Market Insider

Fed signals next up is September rate hike

Key Points
  • The Federal Reserve kept rates on hold and signaled a rate hike is coming in September, with an upgrade in its language on the economy.
  • Stocks, mostly lower on the day, dipped further temporarily and Treasury yields were basically unchanged on the announcement.
  • Market focus now shifts to Friday's jobs report.
  • Earlier Wednesday , the 10-year Treasury yield jumped above 3 percent for the first time since June, in response to stronger U.S. data, but it was trading at about 2.98 percent when the Fed released its 2 p.m. statement after ISM manufacturing data was softer than expected.
Federal Reserve Chairman Jerome Powell speaks at a news conference following the Federal Open Market Committee meetings in Washington, March 21, 2018.
Aaron P. Bernstein | Reuters

The Federal Reserve kept interest rates unchanged and said key drivers of the economy have strengthened, signalling the markets it will hike interest rates in September and possibly December.

Stocks dipped after the 2 p.m. announcement, perceived as slightly hawkish, with the Dow and both at lows before recovering.  Nasdaq, higher as Apple rallied, also lost ground but recovered. However, the Treasury market was little changed, with the 10-year Treasury yield holding slightly lower, at 2.98 percent and the Fed-sensitive , unchanged at 2.67 percent.

"Today is all about the trade tantrum and not policy. That's probably the headline of the day. I think the Fed clearly signaled they're going to continue on their gradual path of interest rate hikes, acknowledged that the labor market continues to strengthen. Inflation is near their 2 percent target. I think all systems are go for September," said Michael Arone, chief investment strategist at State Street Global Advisors.

The Fed statement said that "economic activity has been rising at a strong rate," a more upbeat characterization than the June comment that growth was "solid." It also said that household spending, along with business fixed investment, has "grown strongly." That is also more bullish language than in June when it said household spending has "picked up."

"They remain confident to likely raise rates in September and potentially later in December, but I think it was just a reflection of current conditions and is consistent with Powell's recent comment that the economy was doing very well," said Mark Cabana, head of U.S. short rate strategy at Bank of America Merrill Lynch.

"The market continues to think there's near certain odd, 93 percent chance, of a rate hike in September, and December is tracking over 80 percent," he said.

The outlook for next year is murkier, with the market expecting just 1.6 rate hikes to the Fed's forecast for three, he said.

"We don't know what the drag from trade will potentially be. We don't know how strong the impact from fiscal stimulus will be," said Cabana. 

Cabana said he expects the more interesting aspects of the Fed's meeting to appear in the Fed minutes when they are released Aug. 22, and that could include discussions on its balance sheet, raised by Fed Chairman Jerome Powell in his congressional testimony last month.

As the Fed hikes rates, it has also been paring back on its asset purchases, and Powell said it intends to revisit its policy tools soon. He said that could also be discussed at the upcoming annual Fed Jackson Hole summit on Aug. 23.

Earlier Wednesday, the 10-year yield jumped above 3 percent for the first time since June, in respond to stronger U.S. data, but it was trading at about 2.98 percent when the Fed released its 2 p.m. statement after ISM manufacturing data was softer than expected.

Now the market is gearing up for Friday's July employment report, which is expected to show 190,000 jobs created and average hourly wage growth of 0.3 percent.

"The key to the jobs report, and this has been true for the last several months, is the average hourly earnings. The topline number is going to be strong, and the unemployment rate is going to be at multi-decade lows," Arone said. "The key is strengthening in the labor market translates into higher wages and so far they've been tame...If we do see some further wage gains on Friday, that could be an interesting signal to the market. It would enhance the view that a December hike is more likely."

Arone said a hotter wage number could be negative for stocks and there would be concerns of higher costs for corporations on top of the potential cost increases from tariffs and trade conflicts.