Hey there, forex friends! In case you missed it, the Fed finally pushed through with another long-awaited rate hike after an entire year.
The rate hike itself was widely expected, however, because of recent developments in the U.S. economy, as well as hints that the Fed was worried about its credibility, as revealed by the minutes of the November FOMC meeting.
So, what happened during the December FOMC statement? And why did it trigger such a move from the Greenback? Well, here are four key takeaways that you should know about!
1. Unanimous decision to hike
After an entire year of sitting on their hands, Fed officials voted to raise the federal funds rate by 25 bps to a new target range of 0.50% to 0.75%. Finally!
Not only that, the vote to hike was unanimous, as you can see below.
As to why the Fed decided to finally hike rates, Yellen said the following in her prepared speech:
“[T]he Committee judged that a modest increase in the federal funds rate is appropriate in light of the solid progress we have seen toward our goals of maximum employment and 2 percent inflation.”
In simpler terms, Yellen is saying that U.S. economic conditions were good enough for a rate hike, particularly recent developments in inflation and the labor market. Yellen emphasized this further during the Q&A portion of the presser when she said the following:
“Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made and our judgment that progress will continue… It is a vote of confidence in the economy.”
The Q&A portion also yielded this interesting bit:
“Some of the participants, but not all of the participants, did incorporate some change in fiscal policy into their projections, and that may have been a factor.”
In short,”some” Fed officials may have been convinced to join the rate hike bandwagon by the Trump Effect.
2. Moar rate hikes!
The rate hike was actually widely expected, so forex traders were mostly focused on the future direction of monetary policy. Having said that, the Fed upgraded its rate hike projections, as you can see below.
Okay, let’s break it down. The Fed upgraded its fed funds rate projection for 2017, with the median path now at 1.4%, up from 1.1% previously. And using the top of the new target range, which is 0.75%, as the starting point, that means the Fed thinks there are room for 2-3 25 bps rate hikes in 2017, up from 1-2 hikes.
The extra rate hike in 2017 also pushed up the path of monetary policy in 2018 and 2019. The median expectation for the fed funds rate is now expected to be at 2.1% in 2018, up from 1.9%. This means 5-6 rate hikes, up from 4-5. Projections for 2019, meanwhile, is that the fed funds rate would be at 2.9%, up from 2.6%. This implies room for 8-9 hikes, up from 7-8.
The Fed’s dot plot is even more interesting, as you can see below.
If those dots don’t make sense to ya, then let me try and break it down.
Looking at the December dot plot, we can see that ALL FOMC members, even the non-voting ones, agreed to raise the fed funds rate above 0.50%, so the rate hike was really unanimous.
Moving onward to 2017, we can see that all FOMC members, voting and non-voting alike, agree that the fed funds rate should be above 0.75% by the end of 2017, with two FOMC members open to only one further rate hike while four FOMC members think the fed funds rate should be at 1.125%, which implies that they would agree to two hikes at most. The rest, who form the majority, are open to more than two hikes in 2017.
3. Good times ahead!
The hawkish stuff doesn’t end with the Fed’s upgraded rate hike projections, because the Fed is also forecasting good times ahead for the U.S. economy.
Regarding growth, the Fed slightly upgraded its GDP growth projections for 2016 from 1.8% to 1.9%. The same is true for 2017 (2.1% vs. 2.0% previous) and 2019 (1.9% vs. 1.8% previous) while 2018 was unchanged at a solid 2.0%.
According to Yellen, the U.S. economy is expected to continue growing moderately, thanks to household spending increasing at a “moderate pace”. Yellen warned, however, that business investment “remains soft, despite some stabilization in the energy sector.”
Moving to the labor market, the Fed expected the jobless rate to be at 4.7% by the end of the year, which is a tick higher than November’s 4.6% reading, but better than the Fed’s earlier forecast of 4.7%.
The Fed then expects the jobless rate to drop to 4.5% and hold steady there until 2019, which is better than its September projections that the jobless rate would be at 4.6% by the end of 2017, improve to 4.5% in 2018, before ticking back up to 4.6%.
Yellen did acknowledge the downward trend in the labor force participation rate, but she tried to give it a more upbeat spin by saying that it stems “largely from the aging of the U.S. population” rather than lack of job opportunities, as implied by a large number of low-wage jobs and part-time job holders.
The Fed’s inflation projections for 2017, 2018, and 2019 were unchanged. But its projections for 2016 were revised higher from 1.3% to 1.5%, thanks to further strengthening in the jobs market and fading “transitory influences of earlier declines in energy prices and prices of imports.”
4. On Trumponomics
As I noted earlier, the Trump Effect may have tipped the balance for “some” Fed officials to join the rate hike camp. And during the Q&A portion, Yellen was pressed on this issue.
One reporter asked Yellen about a possible scenario in which fiscal policy is introduced, but it does not result in higher production capacity. The question to Yellen and the Fed, therefore, is if they would respond by hiking even faster.
And Yellen responded as follows:
“It is something I can’t generalize about, because while it would be desirable to have tax policies that do increase the productive capacity of the economy, an increase in the pace of productivity change is one of the factors that does affect the economy’s neutral rate, a boost to productivity could spur investment. As we have been saying, we estimate that the value of the neutral federal funds rate is quite low, and one of the reasons for that is slow productivity growth. So it’s very hard to generalize about it, because it could affect that neutral rate.”
In short, Yellen used some Matrix-like evasive maneuvers to dodge the question.
The journalists apparently wanted clarity, however, and so one of them blatantly asked Yellen just how much fiscal stimulus the economy can take before the risk of overheating grows.
And Yellen was forced to answer thus (emphasis mine):
“Well, I believe my predecessor and I called for fiscal stimulus when the unemployment rate was substantially higher than it is now. So with a 4.6% unemployment rate, and a solid labor market, there may be some additional slack in labor markets, but I would judge that the degree of slack has diminished. So I would say at this point that fiscal policy is not obviously needed to provide stimulus to help us get back to full employment.”
In summary, fiscal stimulus is not needed at this point, which implies a chance that the economy may overheat should Trump push through with his plans. Whether that would then prompt the Fed to hike faster than projected wasn’t answered, but Yellen’s refusal to give a straight answer does seem to imply that the Fed would respond by hiking faster. Sweet! Potentially even moar rate hikes!
As a side note, Yellen was probably thinking about her own job security because she quickly added the following:
“But nevertheless let me be careful that I am not trying to provide advice to the new administration or to Congress as to what is the appropriate stance for policy. There are many considerations that Congress needs to take account of and many bases for justifying changing fiscal policy.”
In short, Yellen is saying that “You’re the boss-man Mr. Trump, sir. You and Congress go ahead and do whatever you have to do.”
Again, the December rate hike was widely anticipated. However, the extra rate hike in 2017 was not, so the market was likely pricing that in. Also, the market probably wasn’t expecting Yellen’s reply about additional fiscal stimulus possibly resulting in an overheating U.S. economy, as well as hints that the Fed may hike faster than projected as a response.
As to when the next rate hike will likely be, the CME Group’s FedWatch Tool indicates a 78.5% probability of a rate hike by the June 2017 FOMC meeting. Before that, the probability of a further rate hike is less than 50%.