As expected almost universally, the Federal Reserve Open Market Committee (FOMC) raised the Federal Funds Rate by 25 basis points on March 15, leaving the “target range” for the key rate between 0.75% and 1%. This is their third rate hike in the last decade and second in four months. Further, the Fed’s forecasts imply two further increases of a similar size later this year.
Nevertheless, we see three unusual things going on. First, markets seem to be viewing the Fed as remaining somewhat restrained. Treasury yields actually fell on the news, perhaps because markets expected a more aggressive assessment of future increases. Market players seem to view the Fed as overly dovish and wonder why this level of accommodation is warranted with unemployment below 5%.
In contrast to the markets' sensibilities, the FOMC appears to see itself in real transition, moving from a responder and reactor to economic developments, towards serving a proactive leadership role. Compared with February’s assessment, the FOMC has an improved view on the economy, stating that business investment has “firmed somewhat”, compared to February’s “remained soft” remarks. They see inflation as now “moving close” to the target, versus “still below” in February.
But third, the economy itself is only grudgingly improving, if at all. While economic data has indeed firmed, neither wages nor GDP are actually escalating yet. The Fed’s own forecast for GDP growth in 2017 is 2.1%, which is not much different from recent performance.
In sum, we believe the Fed is walking a fine line here. They expect an improved economy and the increase in rates reflects that anticipation. At the same time, the Fed still remains highly accommodative and is hedging its bets, in case their own forecasts do not play out.
We anticipate more clarity will come in June, when the Fed’s economic forecasts will again be revised. Economic data between now and then could provide an excuse to hike rates at that point as well as signal the potential for further increases later in the year.
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