Mattias Bruér from SEB Research and Strategy:
As widely expected, for the first time since 2006 the Fed announced that it is raising interest rates thus making the zero interest policy history as of today. The target range for the fed funds was taken to 0.25-0.50 per cent with none of the 10 voters dissenting. The decision seem to have injected confidence in stock markets, while 2-year yields rose a few points to the highest levels seen since April 2010.
As we expected, the median of the dot plots was unchanged at 1.375 per cent with respect to 2016 but lowered somewhat for 2017. So basically the Fed is expecting a 25 bps increase at every quarter for the next two years - this is what "gradual" may look like although the path certainly will be data dependent. With the employment side of the dual mandate achieved already, it is the inflation data that will enter center stage going forward.
Arguably the Fed's economic forecasts for coming years are less than upbeat, so by implication the bar for the gradual thightening is set relatively low. For example, our forecast is for US real GDP growth of closer to 3 per cent in 2016 while the Fed is looking for a more modest 2.4 per cent growth. Markets, meanwhile, remain sceptic that the Fed will actually deliver even such a normalization; indeed other developed countries such as Sweden that have raised rates after the financial crisis have had to lowered them again.
Our view, however, is that the US economy is on a comparably strong footing and that the Fed will actually hike rates at almost every other meeting going forward. But a repeat of the 2004-2006 experience when the Fed hiked at 17 meetings in a row isn't in the cards; with respect to 2016 we are looking for hikes in June, September and December thus taking the target range to 1.00-1.25 per cent by the end of next year. In general, the new Fed projections were surprisingly little changed compared to the outlook in September. Core PCE inflation is seen a tenth lower both this year and the next while the unemployment rate is expected to level out at 4.7 per cent now against 4.8 per cent previously. No big deal as far as forecast changes go, but wth respect to the unemployment rate we like to say that in the complete history of the series it has never happened that the unemployment rate just levels out at the NAIRU. It always, always go below and our forecast is indeed for the jobless rate to decline to closer to 4 per cent over the next few years. If that isn't creating more wage pressures eventually, the laws of supply and demand can be trown in the trash.
In the press conference, Janet Yellen said that the economic recovery has clearly come a long way although it is not complete. While the current expansion is long already, it is a myth that expansion die of old age according to Yellen. We certainly agree; recessions come when the Fed has inverted the yield curve. This is actually why we do not fear the first 100-200 bps of Fed tightening much. While the Chair has suggested before that she would like to see inflation actually turning higher before raising rates again, she backtrack from that statement did repeat that message today. Instead she referred to the wide range of variables that the Fed is watching when making the decisions. So since inflation is as low as it is today, if anything that was a hawkish surpise at the margin. But on the other hand, according to the statement the FOMC "will carefully monitor actual and expected progress toward its inflation goal so our advice is certainly to monitor those inflation numbers. Finally, the understatement of the day must have been when Yellen said that the move was not unanticipated.
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