FOMC Delivers on Rate Hike, Promises Three Hikes in 2017

The Federal Reserve, on Wednesday pulled the trigger on rate hikes in a widely anticipated and well telegraphed move. The central bank was seen raising the fed funds target rate by 25 basis points, pushing the short term interest rates to 0.50% – 0.75%. Besides the rate hike, the Fed gave little hints on how policy makers will respond on a possible shift towards an expansionary fiscal policy which is seen as lifting some burden off the central bank in supporting the U.S economy.

Policy makers at the two-day meeting which concluded on Wednesday, December 14th voted unanimously to hike interest rates. It marks the second rate hike in almost a year after the Fed hiked rates for the first time in December 2015, after a decade of slow economic progress lifted by easy monetary policy.

“In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent,” the FOMC statement said. “The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a return to 2 percent inflation.”

In its statement, the Fed cited strong growth and a steady economic expansion which showed evidence that the U.S. economy was ready to absorb higher interest rates. The Fed also upgraded its assessment of the economy to calling it a “moderate pace of growth.”

On inflation, the Fed said that inflation had increased although not qualifying the statement it said that the broad market based measures of inflation was starting to move up considerably.

Fed signals three rate hikes in 2017


Longer run summary of economic projections for Fed funds rate (Source: St. Louis Fed)

Wednesday’s monetary policy decision was widely expected as investors have been bracing for a rate hike since the November presidential elections. The markets rallied, contrary to initial expectations after Trump won the elections stoking expectations that the president-elect will increase spending by nearly $1 trillion to boost infrastructure which could see inflation rise higher.

For the year ahead, the Fed signaled the possibility of three rate hikes, which could effectively bring the fed funds target rate to 1.25% – 1.50%. The forecasts were hawkish than the market expectations of only two rate hikes. Still, memories of last December remain strong where the Fed forecasted four rate hikes in 2016. However, this time it could be different especially if the expansionary fiscal policies are followed through.

On employment, the policy makers projected the unemployment rate to remain within 4.7% – 4.5% for 2017 through 2019 while expecting an average unemployment rate of around 4.8% by 2018.

In the post-FOMC press conference, Janet Yellen said that the decision to hike rates was to be seen as the Fed’s confidence in the progress of the U.S. economy and that further ongoing recovery will continue.

Despite the Fed’s decision to raise rates has been expected for nearly a month, the markets were mixed in their reaction. The U.S. equity indexes all closed in the red yesterday, including gold prices. However in comparison the pace of declines in gold prices was much stronger as gold futures were seen falling by over 1% on the day.

Yields on the ten-year US treasury edged closer to reaching Monday’s highs of 2.52% while the dollar was seen extending gains by Wednesday’s close. The USDJPY posted fresh highs, rising to a 10-month high by Thursday with the dollar seen trading near the 118.00 handle.

With the markets slowly winding up for the year-end holidays, trading is likely to remain thin although the U.S. equity markets remain trading near all time highs. Investors are likely to expect the ‘Santa rally’ which if materializes could see the Dow Jones inch higher into posting new all-time highs.