Will We See Three Fed Rate Increases In 2018?

Why we might not see a higher funds rate next year.

Federal Reserve officials have indicated they see three rate increases necessary next year to achieve a neutral Fed policy. The implication is the federal funds rate would rise to 2% which would match what they hope will be a 2% inflation rate. But, what if the inflation rate doesn’t rise?

The year-over-year Core Consumer Price Index (CPI) rate is 1.8%, close to the 2% target, but the Fed’s preferred measure of inflation, the Core Personal Consumption Expenditures price index is only 1.3%. If that rate does not budge and the Core CPI drifts down a notch or two, inflation will be stuck around 1.5% or lower.

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With an inflation rate of 1.5% or lower, a neutral federal funds rate target would be 1.5%, which will be the high-end of the funds range after the expected December increase. The Fed could still tighten next year if the unemployment rate continues to fall, tax reform boosts the economy, and stock prices soar, but they would be hard-pressed to justify an increase in the funds rate significantly above a neutral rate.

I still believe we’ll see more inflation, but we’ve yet to see a sustained upward move. If you’re penciling in a steady climb in the funds rate in next year’s budget, make sure it’s written in pencil. It’s not time to ink in a higher funds rate.

Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.

November 16, 2017

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