Fed Watch: 1 hike now + 3 in 2017 = optimism

12-14-2016

While the Federal Open Market Committee’s (FOMC) unanimous 0.25% basis point hike in the target federal funds rate came as expected, Fed policymakers did surprise the market by increasing expectations for hikes over the next three years, including signaling three more for 2017 alone.

The policy-setting committee bumped up its projections for the year-end target rate by 28, 23 and 40 basis points, respectively, for the next three years, pushing a terminal rate that had been falling steadily over the last several meetings to 3%. The FOMC’s formal statement noted that inflation expectations had picked up “considerably” and that the labor market was continuing to tighten, raising the likelihood that wage pressures were starting to build. In its Statement of Economic Projections—commonly referred to as the “dot plot”—the Fed also modestly upgraded the outlook for gross domestic product in the coming years. Through the eyes of the fixed-income market, the projections represented a bearish tilt, as it was assumed that Chair Janet Yellen and her colleagues would not signal a slightly steeper rate path in coming years until it became clear which of President-elect Trump’s pro-growth policies would actually become reality (the uncertainty of which she reiterated in her press conference).

One key question is whether Yellen was one of the voters who moved her dot higher or if she remained at only two hikes in 2017 instead of the three represented by the median.  In any case, she noted in her comments to the press that the target funds rate is only modestly below the neutral rate, and again pledged that rate increases would be “gradual.”