FOMC Dec 2017: Fed hikes interest rates as expected

 

Summary:

• Federal Reserve hiked its benchmark interest rates by quarter percentage point to a target range of 1.25% – 1.50%
• Two FOMC members voted against the rate hike; Evans and Kashkari
• The FOMC’s economic projections estimated that GDP will rise 2.5%, up from the 2.1% estimates it gave previously
• FOMC also gave a modest boost to inflation projections as it forecasts a 1.7% increase, up from 1.6% that was previously estimated
• S. labor market expected to remain strong and that conditions will strengthen further
• Fed projects three rate hikes in 2018

 

The Federal Reserve concluded its two day monetary policy meeting releasing the statement on Wednesday last week. As widely expected, the FOMC did what everyone expected, that is hiking interest rates by 25 basis points. This brought the fed funds rate to 1.25% – 1.50%, the rate at which the central bank pays for reserve balances.

 

 

The Fed’s rate hike was widely anticipated with the futures markets showing a near 100% probability of a rate hike. Last week’s rate hike was the third move from the central bank in 2017 and it matched the central bank’s median projection for rate hikes it gave the year before.

The Fed Chair Janet Yellen said that the expected tax cut proposals could provide additional support to the economy. She said that most of the officials had factored in this prospect.

The Fed chair however expressed concerns that the impact of the tax cuts could be felt on the national debt. Ms. Yellen said that the tax cuts are likely to turn a significant problem into something worse.

Justifying the rate hikes, the Fed Chair said that some officials expected the job growth to cool as the central bank hikes rates gradually. She said that delaying rate hikes could bring the risk of faster rate hikes at a later stage in order to keep the economy from overheating.

 

Evans and Kashkari vote for no rate hike

 

At the December meeting, the decision to hike rates was not unanimous. Two dissenting votes came from the Chicago Fed President Charles Evans and Minneapolis Fed President Neel Kashkari. Both the members were known to be doves.

The dissenting votes cast a shadow on the Fed’s rate hike as it highlighted the growing concerns among some Fed officials on the pace of inflation increase. Previously, Evans said that his decision to vote for a rate hike would depend on how inflation expectations would rise.

Kashkari on the other hand had been repeatedly voting in favor of no rate hike as he had previously dissented in the March and June monetary policy meetings.

 

Headline inflation rises, but core inflation unchanged

 

Ahead of the Fed meeting, the November inflation data showed that headline consumer prices rose 0.4% on the month as expected. This was a higher pace of increase compared to October’s 0.1% gain. On a year over year basis, consumer prices stood at 2.2%.

While this might have been good news, the fact that core inflation rate which strips the volatile food and energy prices did not change. Core CPI was seen rising 0.1% in November following a 0.2% increase in October. This was below forecasts of a 0.2% increase.

The gain in the headline CPI came on account of higher shelter prices and higher prices for vehicle insurance, used cars and trucks. On a year over year basis, core CPI was seen rising 1.7%.

 

U.S. dollar slips after Fed rate hike

 

The U.S. dollar did not react much to the Fed’s announcement as the central bank hiked rates. This was partly to do with the fact that the Fed said that they don’t expect inflation to rise rapidly amid slow pace of wage growth.

The Greenback declined as the Fed’s statement and the projections were widely expected by the markets. Lack of hawkish inclination from the Fed saw a subdued response from the USD.