Fed hikes rates – More hawkish than expected

5 14

Summary:

  • Federal Reserve hikes interest rates by 25 basis points as widely expected
  • Short term interest rates now at 1.0% – 1.25%
  • Central bank maintains the view that one more rate hike is appropriate this year
  • No major changes given to economic projections
  • Inflation expected to weaken below 2%, but jobless rate expected to average around 4.2%
  • Fed gives more details on how it will begin unwinding the balance sheet

No surprises from the Fed

The US Federal Reserve hiked the short-term interest rates by 25 basis points at yesterday’s meeting. It was widely expected by the markets, although the consumer price index data that came out just before did cast some doubts on whether the Fed would hike.

The Fed’s short-term interest rates now stand at 1.25% as the central bank has been hiking rates for the third consecutive quarter. The Fed had first raised rates in December 2015, from historic lows of 0.25%.

Bright economic outlook

Forward guidance from the Fed was, of course, the major factor that market participants were looking forward to. Surprisingly, the Fed maintained a confident tone about the markets. The Fed suggested that it still views one more rate hike to be appropriate this year.

This was slightly hawkish as the markets were beginning to think that another rate hike will come no sooner than 2018. The Fed also signaled its plans to begin unwinding its balance sheet.

While this information was already known, the Fed gave out more concrete measures on how it will go about unwinding the massive balance sheet that has accumulated since the 2008 global financial crisis.

The unwinding of the balance sheet is expected to start later this year. Once the process begins, the Fed noted that it would reduce the balance sheet at a rate of $10 billion per month. This includes $6 billion in Treasuries and $4 billion in mortgage-backed securities.

After every three months, the amount of the balance sheet reduction will rise by $10 billion with the same proportion, until it reaches the pace of $50 billion per month.

The Fed also gave its view on the economy. Economic growth is expected to change not much this year, and lower unemployment and inflation is forecast. Economic growth projections have remained largely unchanged for this year.

The Fed expects the jobless rate to average around 4.2% in the 2018 – 2019 period. The Fed also noted that inflation would head back to 2% despite the recent weakness.

Global risks?

The confident tone of the Fed was seen by the fact that it removed references to global risks, suggesting that any risks from the global markets are unlikely to deter the Fed from its current policy tightening.

The US dollar initially fell on the news as traders and investors probably booked profits. Towards the end of the day, the US dollar began to pull back higher into the day.

The weakness in the US dollar partly came due to the fact that before the FOMC meeting, the US consumer price index data showed that inflation continued to fall. On a month over month basis, headline consumer prices fell 0.1%, while core consumer prices rose just 0.1%.

This brought the year over year consumer price index to 1.9% from 2% last month, and core CPI rose to 1.7%, from 1.9% previously. Given that CPI is slightly higher compared to the PCE data which is used by the Fed, consumer prices are expected to remain slightly subdued in the near term.

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