At the conclusion of their December meeting, The Federal Reserve’s Open Market Committee voted to raise the target range for the Federal Funds rate by 0.25% to a range of 0.25% - 0.50%, a move that was widely anticipated by the market. In their statement, Fed officials reiterated their recent characterization of the US economy as expanding at a moderate pace with notable strength in household spending and business fixed investment. Recent labor market strength along with stabilization of global economic and financial markets likely provided the more dovish Board members with just enough confidence in their outlook that they were able to reach a consensus to begin the long awaited normalization of monetary policy.
As part of the December meeting, Federal Reserve Board members provided their updated economic projections and their individual assessments of the projected appropriate monetary policy. On the margin, the updated projections were little changed from their September forecasts with a small increase in the median projected growth rate in 2016 and a 0.2 % drop in the median expectation for the Federal Funds rate at the end of 2017. Notably, there were no changes to the members’ median projections for longer-run growth, unemployment rate, inflation or the Federal Funds rate. Currently, markets are anticipating a 0.50% rise in the Funds rate in both 2016 and 2017 while the median projections of Board members are for an increase of 1.0% in both years.
As stated earlier, the rate increase was largely expected by the market, though perhaps market participants were anticipating marginally lower projections for future rate increases as a reinforcement of the Fed’s message of gradualism. As a result, the initial market reaction was relatively muted. Yields on Treasury securities rose only a few basis points from levels prior to the Fed announcement with some flattening of the yield curve between intermediate and long maturities.
Going forward, probably the most important factor impacting the pace of hikes will be the Fed’s inflation outlook. The labor market is near the Fed’s estimate of full employment and near term inflation is likely to continue to be held down by the commodity price declines and dollar strength of the past year. While the Fed sees these factors as transient, the market remains unconvinced, focusing on the higher uncertainty surrounding the managed slowdown in China and the negative impact of the collapse in commodity prices on exporters and producers. Our outlook for US and global growth for 2016 is little changed from 2015. Slowly improving inflation and a trend of tighter financial conditions will likely result in a cautious Fed, though markets appear to be somewhat pessimistic on rate hike expectations and we would expect these to rise somewhat in 2016.
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