Economic Flash

FOMC Hikes to 1.25-1.50%; Expects Better Growth in 2018; Keeps Forward Rate Guidance Unchanged


by Craig Dismuke, Dudley Carter

FOMC Hikes to 1.25-1.50%; Expects Better Growth in 2018; Keeps Forward Rate Guidance Unchanged

 

The FOMC voted for the third time in 2017 to hike its overnight target rate range to 1.25-1.50%.  The hike was largely expected by the markets.  The FOMC Statement noted a strong labor market (calling the market strong or solid three times), acknowledged below-target inflation, and necessarily removed some of the language related to the hurricane disruptions on the economic data.  While the Statement does not include any significant prosaic changes, the contrast between the “strong” labor market and below-target inflation remains evident.  FOMC officials continue to say that they expect inflation to “stabilize around the Committee’s 2 percent objective over the medium term.”

 

There were two dissents to the decision to hike from Chicago Fed Bank President Charles Evans and Minneapolis’ Kashkari.  Both voters have been outspoken in their concern that inflation has remained below-target.  Neither Evans nor Kashkari will be voting members in 2018.

 

There was uncertainty coming into the meeting as to how the Fed’s forward projections might change given the evolving labor and inflation situations.  The December Summary of Economic Projection’s dot plot showed few changes to future rate expectations.  The median Fed Funds rate projection for year-end 2018 remained at 2.125% (implying three more hikes) and the median for year-end 2019 remained at 2.688%.  The median rate forecast for year-end 2020 did increase, from 2.88% to 3.06%  but the median longer-run rate remained at 2.75%.  Interestingly, the one participant with a longer-run neutral rate over 3.00% cut their projection and there are no longer any Fed members projecting a longer-run rate above 3.0%.  As for GDP growth, the projections show a 2018 forecast of 2.5% growth, up from 2.1% in the previous meeting.  However, longer-run growth is still expected to average 1.8%.  Inflation is still not expected to reach 2.0% until 2019 but the unemployment rate is now expected to drop to 3.9% in 2018 versus the previous forecast of 4.1%.

 

The portfolio runoff cap was increased to $20 billion per month as scheduled in the original implementation note.  For the next three months, the Fed is planning to allow $8 billion in MBS and $12 billion in Treasury holdings to roll-off their balance sheet each month as they mature/prepay.

 

Overall, this result is as-expected.  The Fed continues to see risks to inflation from such a low unemployment rate and moved forward with their third hike of the year.  However, inflation remains confoundingly weak keeping them from ratcheting up their forward rate projections.  In a sign of confidence, they moved forward with their balance sheet plans.  The biggest surprise is arguably the faster GDP growth projection for 2018.  Ironically, even with GDP projected to expand 0.7% faster than sustainable and the unemployment rate to be 0.7% below sustainable next year, the Fed still projects inflation to be below their 2 percent target.  While they are confident in the stability of the economy, they remain perplexed by the unresponsiveness of inflation.



FOMC Official Statement

December 13, 2017

 

Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a solid rate. Averaging through hurricane-related fluctuations, job gains have been solid, and the unemployment rate declined further. Household spending has been expanding at a moderate rate, and growth in business fixed investment has picked up in recent quarters. On a 12-month basis, both overall inflation and inflation for items other than food and energy have declined this year and are running below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.

 

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Hurricane-related disruptions and rebuilding have affected economic activity, employment, and inflation in recent months but have not materially altered the outlook for the national economy. Consequently, the Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will remain strong. Inflation on a 12‑month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.

 

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1-1/4 to 1‑1/2 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

 

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

 

Voting for the FOMC monetary policy action were Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Patrick Harker; Robert S. Kaplan; Jerome H. Powell; and Randal K. Quarles. Voting against the action were Charles L. Evans and Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.

 

Implementation Note issued December 13, 2017

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