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One Rate Hike with More to Come

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LiermanThe Federal Reserve today raised the range on the federal funds rate to 0.50%-0.75% as expected by the market. It is the second rate increase during this economic cycle, the first being in December 2015.  The FOMC mentioned in its statement that ”economic activity has been expanding at a moderate pace” and “job gains have been solid” (averaging 180k over the last three months). For the first time the FOMC recognized inflation is moving up toward its 2% long term goal. The consumer price index year-over year sits at 1.6% (up from 0% in September 2015) and looks to be headed higher as wages have increased, the employment cost index is above 2% year-over-year, and some stability in the oil market has been found.

The most surprising take away from today’s meeting is the “Dot Plot”. The FOMC’s forecasts for future interest rates increased by about a quarter point from prior meetings. The median estimate currently forecast calls for three rate hikes in 2017 and for the fed funds rate to end 2017 at 1.4%, 2018 at 2.1%, and 2019 at 2.9%.

Even with a more hawkish tone the Fed’s monetary policy is still accommodative. The Fed will continue to maintain its balance sheet by purchasing treasuries and mortgage back securities with upcoming maturities and principal paydowns. It will continue to coordinate with other central backs and keep an eye on exogenous shocks to the financial system. I think it is fair to say that the Fed is trying to normalize monetary policy after an extended period of non-conventional policy.

Since the November election interest rates have been moving upward across the curve. The statement today should provide a small catalyst for rates to adjust higher.  The risk to the economy and risky assets are for rates to move too high too fast. The start of the normalization of interest rates is predicated on a strong economy and controlled inflation. The markets would like controlled small changes in interest rates. The Fed will have to do an extraordinary job in 2017 to communicate its intentions to the market.

 

William Lierman, CFA®
Chief Investment Officer

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