Last month the Fed’s decision to raise its interest rates by 25 basis points to a target range of 0.50% – 0.75% surprised no one but those who live under a rock.
What WAS surprising was the fact that FOMC members are projecting 2-3 rate hikes when analysts had only expected 1-2 (25-basis point) rate hikes in 2017. What’s up with that?!
We’ve sifted through the latest FOMC meeting minutes to understand what most/several/some/many participants have considered during their meeting. Here are answers to the most common questions!
Why is the Fed more hawkish going into 2017 than it was last year?
In a word, Trumponomics. Though Janet Yellen and her gang have not explicitly mentioned the Donald, the minutes did say that
“Many participants judged that the risk of a sizable undershooting of the longer-run normal unemployment rate had increased somewhat and that the Committee might need to raise the federal funds rate more quickly than currently anticipated to limit the degree of undershooting and stem a potential buildup of inflationary pressures.”
Recall that the biggest reason why the Fed raised its rates in December is that it doesn’t want to let the unemployment rate fall so far that the Fed would need to be even more aggressive in its tightening down the road.
And with President-elect Trump promising to “Make America Great Again” by bringing jobs back home, most members have clearly decided that more rate hikes are needed in 2017 to stem the expected inflationary pressures coming from increased employment.
Did Trumponomics also factor in the upgraded economic estimates?
Yes and no. Though members “generally made only modest changes” to their real GDP forecasts, the minutes also revealed that “almost all” of them added the “prospects for more expansionary fiscal policies in coming years” in their upside risks column.
However, participants also emphasized that there’s still “considerable uncertainty” over the timing, size, and composition of any future fiscal and other economic policy changes and that, depending on the mix of tax, spending, regulatory, and other possible policy changes, economic growth might turn out to be faster or slower than they currently anticipated.
So, what’s the Fed looking out for this year?
In its decision last month, the Fed has upgraded its 2016, 2017, and 2019 GDP and employment forecasts and pushed its 2016 inflation projections higher.
Apparently, upside risks to economic growth include better-than-expected economic improvements abroad as well as acceleration of business investment. Meanwhile, downside risks include a stronger dollar, financial vulnerabilities in some foreign economies *cough* trade war with China *cough*, and the Fed’s low rate limiting its powers to intervene if necessary.
The Fed also thinks that economic growth and further increases in oil prices could push consumer prices higher, while a strong dollar could hold inflation back. Overall, Fed members believe that downside risks remain and that it’s better to adopt a wait-and-see mode until reports prove differently.
How did the dollar react?
The Greenback initially rallied on headlines that the Fed is indeed feeling hawkish, but the fact that “almost all” FOMC participants had already priced in Trump’s PLANNED policies eventually didn’t sit well with dollar players. Of course, it also didn’t help that NFP prospects wasn’t looking too good, and that a lot of market bees were buzzing about heavy retracements for the dollar at the start of the year.
Before you short the dollar like there’s no tomorrow though, you should know that even Fed members think that “it’s too early to know” the impact of any and all policy changes from the new administration. The Fed reminds us that uncertainty over future fiscal and economic policies have increased and that, if realized, might call for a different path of policy than what the members are expecting.