Instant Analysis: FOMC statement for December

Scott Anderson
Posted by Scott Anderson
Chief Economist

I never thought I would live to see the day.  After almost a decade since the Fed last raised interest rates, and seven years at the zero lower-bound, the Federal Open Market Committee (FOMC) decided today to take baby-steps toward interest rate normalization.

Shot of the Federal Reserve on a sunny day.The anticipation was palpable leading up to the decision, but by design the fallout of this momentous decision and the initial market reaction was decidedly lackluster.  Of course, today’s move was well advertised, and the FOMC seemed to take pains to ensure that the initial rate hike decision went down in the markets smoothly.  Fed Chair Janet Yellen managed to herd the cats on the FOMC and got unanimous support for today’s rate hike decision.

The FOMC cited considerable improvement in the labor market this year, and expectations that inflation will move back toward their intermediate 2.0% inflation target over the medium-term as the reason for today’s move. Specifically, the FOMC statement mentioned job gains, declining unemployment, and the fact that underutilization of labor market resources has diminished appreciably since early this year.

The FOMC statement was peppered with language that watered down the move and the initial impact on the market.  As I expected, the statement mentioned the expected gradual adjustment in the stance of monetary policy and the gradual path of further interest rate hikes.  Moreover, the path of interest rate hikes will remain data-dependent.  The FOMC statement mentions the pace of Fed funds interest rate hikes will depend on the economic outlook and incoming data.  The FOMC will continue to weigh a wide range of economic indicators, such as labor market conditions, inflation pressures, inflation expectations, financial and international development.

There appeared a little more concern about the low level of current inflation, but not enough to dramatically change the FOMC median PCE inflation forecasts. However, the median PCE inflation forecasts for 2016 did drop by about a tenth of a percent since September’s meeting. Moreover, the FOMC statement added language that “In light of the current shortfall of inflation from 2%, the Committee will carefully monitor actual and expected progress toward its inflation goal.”  The outlook for U.S. Real GDP growth for 2016 and 2017 was virtually unchanged in the updated Summary of Economic Projections.

The Fed Dot-Plot median did not change as much as we expected.  For example, the FOMC median forecast is still that the Fed funds rate at the end of 2016 will be between 1.25 and 1.50%.  However, there was a reduction in the median Dot-Plot at the end of 2017 by about a quarter percentage point.  In addition the central tendency forecasts on the Fed funds target rate for 2016, 2017, and 2018 also came down from September’s meeting — a sign, perhaps, that their conviction in their ability to hike rates aggressively in coming years is starting to erode.

The market reaction was on the positive side.  The S&P 500 increased 1.0%, 2-Yr Treasury bond yields increased nearly 5 basis points today to 1.0%, while the 10-Yr Treasury yields jumped 3.5 basis points.

Bottom line: The FOMC statement today was largely in-line with our thinking and our outlook for U.S. interest rates. As a result our outlook for the U.S. economy for 2016 is unchanged. The Fed Funds rate hike path will remain gradual and data dependent next year. With that said, the era of zero interest rates is coming to an end in the United States.  Fed liftoff is here, and further Fed interest rate hikes are in our near-term future.

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