Please find our latest blog following yesterday’s FOMC announcement to raise the target range for the Fed Funds rate 25bps to 2.00%-2.25% (as expected).
Policy Normalization on Target
In a unanimous vote, the FOMC voted to raise the target range for the Fed Funds rate to 2.00% to 2.25%. As has been the case for recent changes, this 25 bps hike was well-telegraphed and completely expected by the market, with a recent implied probability of action of effectively 100%. Beyond rate increases, the quantitative tightening policy that began reducing the Fed’s $4.5 trillion stockpile of assets in 4Q-17 will increase its pace again. Beginning in October, principal payments will be reinvested only to the extent that they exceed higher caps. For U.S. Treasuries the new level becomes $30 billion/month, and for Agency MBS the threshold goes to $20 billion/month.
The official statement indicated that “economic activity has been rising at a strong rate.” This can be viewed as an upgrade to the previously “solid” near-term assessment. Accordingly, the median GDP expectations for 2018 and 2019 increased slightly, with 2018’s projection up to 3.1%, a 30 bps increase; and 2019’s projection up 10 bps to 2.5%. That said, 2020’s projection of 2.0% and the longer run projection of 1.8% remained the same. Noticeably, the official press release dropped long-standing language suggesting that “the stance of monetary policy remains accommodative.” Chairman Powell and others had foreshadowed this assertion that the labor markets and inflation no longer require support.
Consistent with recent payroll reports, “job gains have been strong” even as the FOMC makes gradual adjustments to policy. With 95 consecutive months of payroll expansion, the official unemployment rate resides at 3.9%. The Committee increased its central tendency slightly for 2019 and 2020 but left the longer run unemployment at 4.3% to 4.6%. It continues to have median expectations of 3.5% readings in 2019 and 2020. There was no specific mention of wage growth, but the recent 2.9% year-over-year increase in average hourly earnings remains subdued for a maturing cycle.
The statement noted how “Indicators of longer-term inflation expectations are little changed, on balance.” The recently-released Core CPI reading for August moved modestly lower to 2.2% year-over-year but is at the higher end of the 1.6% to 2.4% range that has persisted since mid-2011. The Fed’s preferred measure (Core PCE) has just reached its 2.0% symmetric inflation goal. The Committee will continue to assess “indicators of inflation pressures and inflation expectations.”
The Committee’s forward-looking expectation for rates nudged slightly higher. Another quarter-point hike could occur by year end, which would make it four in 2018 and a total of nine adjustments since policy normalization began in late 2015. The longer run central tendency moved up slightly to 3.0%, even as front-end rates are anticipated to rise 0.375% above that terminal level by 2020. The market is consistent with FOMC forecasting through 2018 but continues to discount adjustments somewhat further out as many observers expect a pause in mid-2019.
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