FOMC Watch: Stay on the Hiking Trail

By Kevin Flanigan, WisdomTree Senior Fixed Income Strategist

No surprise here: The Federal Open Market Committee (FOMC) delivered its second rate hike of 2018. The quarter-point increase pushed the target range for the Federal Funds Rate up to 1.75% to 2.00%. Based upon the Federal Reserve’s (Fed) outlook, it would appear as if further gradual rate hikes are still the more likely scenario going forward, but interestingly, there have been some shifts in attitude regarding just how many additional moves could be forthcoming.

Heading into the June FOMC meeting, market expectations were certainly priced for a rate increase, as the implied probability for Fed Funds Futures was essentially at 100%. However, the outlook for the remainder of 2018 has changed a bit in recent weeks. In mid-May, Fed Funds Futures were pointing toward the possibility of two additional increases for the remainder of this year but were dialed back to only one further hike as of this writing. A similar development occurred with respect to the 2019 outlook.

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It is interesting to note that the recent peak in the Fed Funds Futures gauge occurred at the same time the U.S. Treasury (UST) 10-Year yield broke through to the upside, posting its highest reading since 2011. What happened in the ensuing period to serve as a potential catalyst for this shift in Fed outlook? In one word: Italy. The political turmoil and attendant risk-off trade caused by the unsettled situation in Italy appears to be a notable factor for the aforementioned scaling back of rate hike expectations. Indeed, surging Italian bond yields combined with concerns of a contagion effect on eurozone banks created a flight-to-quality trade that not only pushed the UST 10-Year yield down more than 30 basis points (bps) at one point, but also apparently impacted expectations for potential Fed policy moves.