Federal Reserve (2)

The recent sell-off in stock markets seems to have occurred because of fears that the recent run of strong data on the US economy may precipitate more hikes in US interest rates than previously expected. Yesterday, the FED (US central bank) spoke, and the fears seem to have been confirmed.

"A number of participants indicated that they had marked up their forecasts for economic growth,” said the latest minutes from the FOMC, the committee at the US Federal Reserve (FED) charged with the responsibility of deciding interest rates. The minutes continued: “A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate."

It seems that with the US economy apparently strong, unemployment so low, and with the US President planning tax cuts without a corresponding cut in government spending, fears that the US economy is in danger of overheating are growing.

That’s why stock markets have taken something of a fright in recent weeks.

Paul Ashworth, Chief US Economist at Capital Economics said: "We have long expected the Fed to hike interest rates four times this year, on the basis that Congress would loosen fiscal policy and core inflation would rebound markedly in 2018. That view is now rapidly gaining traction in the markets and among other economists. Fed officials themselves are still projecting three rate hikes, but were clearly more focused on the upside risks at this meeting.”

Markets are slowly pricing in the possibility of four hikes in US interest rates this year. There has to be a risk, however, that the Trump tax cuts will lead to a sharp rise in inflation, creating the need for even more rate hikes. If the markets start thinking this might happen, further falls in the stock market may well be the result.