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Fed Hikes, Sees Three More in 2017–A Year Ago it Saw Four in 2016

Summary:

 

Biggest change is that Fed sees three instead of two hikes next year.

Minor tweaks in the forecasts.

Fiscal policy could raise the long-run growth potential, which would be a net good but not needed to reach full employment.

pullingAs has been tipped since at September the Federal Reserve increased the Fed funds target range by 25 bp to 50-75 bp.  The market’s understanding of the Fed reaction function and the communication left little doubt in the mind of investors that rates were going up today.  However, there is little additional information or guidance offered.  Visibility has diminished by the election and the unknown state of fiscal policy going forward.

The  FOMC statement tweaked the economic assessment to reflect the recent economic data.   However, officials seem more confident that although growth is unspectacular it is not as fragile as it may have appeared.  The Fed did recognize the unemployment rate has declined, while in November, it was still little changed.

It also recognized that “market-based measures of inflation compensation,” which is the yield curve and the breakevens, have moved up “considerably,” which is a new qualifier.  However, it still assessed these to be low. This seems to be behind the increase in the number of rate hikes that are seen as appropriate next year from two to three.  The Fed funds futures had priced in two hikes by the end of next year.  On the other hand, economists in a recent Wall Street Journal survey anticipated three hikes.

The economic projections adjustments were mild, taking growth slightly higher, but growth over the next three years is currently not expected to be above 2.5%.  Obama is the first president since the Great Depression that has not experienced one year of his term with 3% or higher growth. Unemployment is expected to drift lower.  The central tendency does not show the core PCE deflator rising above 2.0% until 2019.  The median long-run Fed funds expected was raised to 3.0% from 2.875% in September.  To the extent that the long-run GDP forecast is the same as trend growth, it is notable that it was lifted to 1.8%-2.0% from 1.7%-2.0%.

 The curve flattened in response to the Fed’s anticipation of three hikes next year.  The December 2017 Eurodollar futures yield rose 10 bp, and the two-year yield rose six bp, while the 10-year yield rose 3.  The dollar strengthened across the board, with the dollar moving above JPY116 for the first time in ten months.  The US two-year premium over German jumped to almost 200 bp.  The German two-year yield fell to a new record low today.

Yellen acknowledged that fiscal policy is one of the major factors that could impact economic conditions and monetary policy.  In her press conference, Yellen played down the changes to the forecast suggest hat that they were very small and reflected the changes of a few members. She was not baited by questions about the fiscal stimulus promised by the President elect.  She explained that some supply-side changes could boost growth potential and not be inflationary.

 

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Marc Chandler
He has been covering the global capital markets in one fashion or another for more than 30 years, working at economic consulting firms and global investment banks. After 14 years as the global head of currency strategy for Brown Brothers Harriman, Chandler joined Bannockburn Global Forex, as a managing partner and chief markets strategist as of October 1, 2018.
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