Fed raises rates, sees faster pace of increases in 2017

The US Federal Reserve raised interest rates by a quarter point on Wednesday and signaled a faster pace of increases in 2017 as the Trump administration takes over with promises to boost growth through tax cuts, spending and deregulation.

The rate increase, regarded as a virtual certainty by financial markets in the wake of a string of generally strong economic reports, raised the target federal funds rate 25 basis points to between 0.50 per cent and 0.75 per cent.

US bond yields moved higher and the dollar rose against a basket of currencies after the Fed’s unanimous policy decision. US stocks were trading marginally lower, but selling picked up speed during Fed Chair Janet Yellen’s subsequent news conference.

Yellen indicated the central bank was, at the margins, adapting to Trump as “some of the participants” on the rate-setting Federal Open Market Committee began shifting fiscal policy assumptions.

“We are operating under a cloud of uncertainty … All the FOMC participants recognise that there is considerable uncertainty about how economic policy may change and what effect they may have on the economy.”

Partly as a result of the anticipated changes, the Fed sees three rate hikes in 2017 instead of the two foreseen in September. Yellen called that a “very modest adjustment” driven by strong job gains, evidence of faster inflation, and the expected impact of Trump’s policies.

But she also said Wednesday’s rate increase should be “understood as a reflection of the confidence we have in the progress the economy has made.

In addition to its policy statement, the Fed issued fresh economic forecasts that indicated the current once-a-year pace of rate increases will accelerate next year. Markets and the Fed appeared to be close on their rate outlooks, with Fed futures markets pricing in at least two and possibly three hikes in 2017, up from one to two prior to this week’s meeting.

With President-elect Donald Trump planning a simultaneous round of tax cuts and increased spending on infrastructure, central bank policymakers shifted their outlook to one of slightly faster growth, lower unemployment and inflation just under the Fed’s 2 percent target.

The Fed’s projected three rate increases next year would be followed by another three increases in both 2018 and 2019 before the rate levels off at a long-run “normal” 3.0 per cent. That is slightly higher than three months ago, a sign the Fed feels the economy is still gaining traction.

“They didn’t mention the fiscal stimulus but typically their aggressiveness does indicate that there’s a little more confidence that they can get away with three hikes next year,” said Aaron Kohli, interest rate strategist at BMO Capital Markets.

The Fed continued to describe that pace as “gradual,” keeping policy still slightly loose and supporting some further improvement in the job market. It sees unemployment falling to 4.5 per cent next year and remaining at that level, which is considered to be close to full employment. The economy is projected to grow 2.1 per cent in 2017, up from a previous forecast of 2.0 per cent.


TRUMP IMPACT

U.S. bond yields had already begun moving higher following the Trump’s Nov. 8 victory and as expectations of the Fed rate increase solidified. By the start of this week, trading in fed funds futures assigned a greater than 95 percent likelihood to a rate hike, according to data compiled by the CME Group.

All 120 economists in a recent Reuters poll had expected a rate hike on Wednesday.

In the weeks following the election, Fed policymakers have said Trump’s proposals could push the economy into a higher gear in the short run. Even though the details of the Republican businessman’s plans remain uncertain, Wednesday’s statement marked a rare case in the post-crisis era in which the Fed moved its interest rate outlook higher.

Risks to the outlook remain “roughly balanced” between factors that could slow or accelerate the economy beyond what the central bank anticipates, the Fed said, no change from its assessment last month.

The rate increase was the first since last December and only the second since the 2007-2009 financial crisis, when the Fed cut rates to near zero and deployed other tools such as massive bond purchases to stabilize the economy.