10 Jan 2017
A Slightly More Hawkish Fed
The Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points—to a range of 0.50-0.75%—for the first time in 2016; having raised rates initially a year ago at this same time. The Fed also raised the discount rate to 1.25% from 1.0% and the rate paid on required and excess reserves to 0.75% from 0.5%. Also moving up were the Fed's expectations for the trajectory of rate hikes in 2017; with three additional hikes expected in 2017, up from two last September (based on median estimates of FOMC members). In general, the change in expectations for next year were seen as evidence of a slightly more hawkish Fed.
"Considerable" inflation pressures?
Of note in the accompanying statement was the use of the term "considerably" to describe the increase in inflation expectations; and the mention of tightening labor conditions. The Fed said monetary policy supports "some further strengthening in labor market conditions and a return to 2 percent inflation." The addition of the word "some" was seen as an indication that there will be more muted improvement in job growth next year; while "strengthening" replaced "improvement" from the Fed's September statement.
Although expectations for future rate hikes lifted, the Fed's statement did repeat verbatim the language about the pace of rate hikes: "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
Initial market impact
In the immediate aftermath of the Fed's announcement U.S. stocks sold off; with the Dow Jones Industrial Average giving back over 200 points and moving from the green to the red on the day, before rebounding toward the close of trading. The bond market also sold off, with the yield on the 10-year Treasury note moving higher (remember, bond yields and bond prices move inversely). On the upside was the U.S. dollar, up over 1% from the low of the day.
The convergence between the Fed's expectations and the market's expectations ostensibly lessens the risk of surprise Fed decisions in 2017. However, given the Fed's expectation of three hikes, the March 2017 meeting is likely to be considered "on the table." Uncertainty around the timing of the next hike—as well as continued strength in the dollar—could lead to some market volatility.
Press conference highlights
Of course, the incoming Trump administration has promised a significant amount of fiscal stimulus—through both tax and regulatory policy, in addition to government spending. At the beginning of Fed chairwoman Janet Yellen's press conference she noted that some Fed officials may have already taken account of potential fiscal stimulus when establishing their federal funds rate projections, but she suggested most had not. This is another reason why many now believe there is a risk the Fed will have to move more aggressively next year—if Trump's policies lead to a meaningful pick-up in growth.
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