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6 takeaways from the December Fed meeting

Our Blog Dec 15, 2016
Edward Al-Hussainy, Senior Interest Rate and Currency Analyst

The Fed’s latest rate hike came as no surprise. The big story in this month’s meeting is that the FOMC now expects to raise rates three times in 2017.

In the December Federal Open Market Committee (FOMC) meeting, the Federal Reserve raised rates another 25 basis points. While the hike was widely expected, it’s noteworthy that the Fed is now anticipating three rate hikes in 2017 instead of two under its prior forecast. Here are six quick takeaways on the Fed’s move toward interest rate normalization:

1. More is expected in 2017. Essentially, the FOMC added one additional quarter-point hike to its outlook for 2017. This has surprised markets, leading to higher front-end rates, a flatter curve and a stronger dollar. However, we see room for caution: it remains too early for FOMC members to work changes in fiscal and trade policy into forecasts for growth and inflation for 2017 and 2018.

2. Growth and inflation forecasts haven’t changed. The Fed’s growth and inflation forecasts remain broadly unchanged. The economy is close to full employment, but core inflation remains sticky below the Fed’s 2% target for the forecast horizon.

3. The dot plot is an imperfect tool. The FOMC’s "dot plot" shows where each member thinks the fed funds rate should be at the end of the year for the next few years and longer term. While the dot plot is not an official policy tool, it offers insight into member views on monetary policy. We have cautioned that the dot plot is an imperfect tool for forward guidance. Until we get greater clarity from the new administration and Congress about changes to fiscal and trade policies, FOMC members will be incorporating potentially dramatically different assumptions about how these changes will affect inflation and growth.

4. Markets are pricing in a reasonable path to higher rates. Intermediate Treasury yields (2-5 years) have now risen a substantial amount in the second half of the year, with the rise in the 5-year yield now exceeding 100 basis points. At current levels, the market is pricing in a very reasonable hiking path, and yields are high enough that government bonds can act as a nice shock absorber in portfolios from current levels.

5. Longer term yields haven’t moved much. Longer term Treasury yields have seen very little changed on this news but could be at risk of moving higher if any of the following happen:

    • Inflation rises unexpectedly.
    • Fiscal stimulus raises inflation expectations and creates large supply of the longest term Treasuries.
    • Foreign central banks move to unwind their large-scale government bond purchases.

6. Like the rest of us, the Fed is waiting to see what president-elect policies will be. When asked about the impact of President-elect Trump’s policies on growth and inflation, Fed Chair Janet Yellen described it as too soon to assess the impact of anything that has been proposed (re: tax cuts, infrastructure spending, etc.).

Bottom line

While the December rate hike was widely expected, the addition of another rate hike in 2017, bringing the expected total to three, was not. Longer term yields haven’t changed much, nor have growth and inflation forecasts. Caution is the watchword as the Fed takes a wait-and-see approach to how big an impact the new administration’s policies will have on the U.S. economy.

Edward Al-Hussainy

Edward Al-Hussainy

Senior Interest Rate and Currency Analyst