17 December 2015

US Fed raises rates

As largely priced-in, the Fed raised the target range for its fed funds rate by 25 basis points yesterday, to between 0.25% and 0.50%.


However, somewhat unexpectedly, it did not shift its previous outlook by lowering it s projections for the pace of future rate hikes. Additionally, the vote to raise rates was unanimous, which could also appear to be hawkish in outlook. The path of future projections had been widely expected to abate, projecting more gradual increases in the future.

By way of justification, it was noted that there had been 'considerable improvement' in employment conditions this year and that the Federal Open Market Committee (FOMC) is now 'reasonably confident' that inflation will climb back to the 2% target in the medium term. The FOMC is distinctly focusing on these key domestic parameters rather than the international factors cited as a concern in September.

The FOMC is however quite clear in its remarks that it 'expects that economic conditions will evolve in a manner that will warrant only gradual increases in the fed funds rate'. It is also emphasised that future hikes will follow only because 'the actual path of the fed funds rate will depend on the economic outlook as informed by incoming data'.

As the FOMC has increasingly stressed in its output of recent months, everything is dependent upon the economic data flow. With the full employment part of its stated mandate already largely achieved, the data the Fed will be watching most closely is for any resultant inflation trends. The new statement notes that the FOMC 'will carefully monitor actual and expected progress toward its inflation goal.' The overall message from the Fed statement is one of “gradualism”.

Looking at the new FOMC forecasts for their forward looking matrix, there was little change which may have surprised some commentators. The GDP growth, inflation and unemployment projections were largely unchanged, with any shifts being very marginal. The interest rate forecasts did not change much as a result of this. The Fed remains of the view that the fed funds rate will be at 1.4% for the end of 2016 and the end-2017 forecast was revise down only slightly to 2.4%, from 2.6%.

This caution being retained in forward forecasts may imply that inflation could rebound that bit more swiftly than the Fed believes in early 2016, as the deflationary pressures from lowered commodity prices and the strength in the US dollar begin to work their way through the data series. This could be exacerbated if domestic price pressures continue to build from the resurgent US consumer, with an added boost from even lower oil prices. If this combination of factors did coincide, one could envisage the fed funds rate at nearer 2% by the end of next year, driven by strength in the underlying data series. What one has to be clear on here is that the FOMC has left the door fully open, and its future forecasts unchanged, on a pro-active path of rates, should the underlying circumstances dictate them.

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