Federal Rate Hike Predictions
Observers will be watching the Federal Reserve this week as Jerome Powell leads his first meeting as chairman. Alex Hsu, an assistant professor of finance in Georgia Tech’s Scheller College of Business, explains why the Federal Reserve should increase rates and how many rate hikes we can expect this year.
There are several reasons why the Federal Reserve should increase rates in 2018. First, the economy is booming. All indicators underpinning the real economy, such as jobs creation and corporate earnings, are positive. Nominal rates should be stepped up to normalize economic activity.
Furthermore, as the main monetary policy instrument, the short rate needs to be comfortably away from the zero lower bound before the next recession hits.
Finally, there are ample signs that cash investors are seeking risky yields because U.S. Treasury yields are not attractive enough. For example, mergers and acquisitions are near all-time highs, suggesting investors are taking extremely levered positions because borrowing is cheap. This is a danger to the health of the financial system. Higher federal fund rates can alleviate some of this behavior.
The expectation from academics and Federal Reserve watchers at the beginning of the year was that there will be four rate hikes in 2018. However, anecdotal evidence suggests that market participants are expecting a number lower than four and in the range of two. I believe ultimately, there will be three hikes in 2018 as the Federal Reserve is conscientious of the stock market outlook.