Policy Normalization on Target: Despite a pair of more dovish dissenters, the FOMC voted to raise the target range for the Fed Funds rate to 1.25% to 1.50%. This 25 bps hike was well-telegraphed and completely expected by the market, with a recent implied probability of action very near 100%. Having undershot their own expectations in 2015 and 2016, the FOMC achieved its projected path of normalization for the year. Beyond rate increases, it’s notable to mention the quantitative tightening policy that began reducing the Fed’s $4.5 trillion stockpile of assets in October. The pace of this roll-off will escalate as planned in January, with principal payments being reinvested only to the extent that they exceed rising caps. For U.S. Treasuries the new level becomes $12 billion/month, and for Agency MBS the threshold goes to $8 billion/month.
Growth: The official statement indicated that “economic activity has been rising at a solid rate”. This phrasing appears to be an upgrade from the “moderate” characterization of prior FOMC statements. Median GDP expectations for 2017 through 2020 were all revised higher, with next year’s projection of 2.5% showing the most upward mobility. In her final press conference, Chair Yellen indicated that forward growth forecasts increasingly incorporated policymaker views on how tax cuts could impact the economy. She also refuted claims of “gigantic” growth to come, and noted that big deficits hamper the ability to fight recession. The latest central tendency estimate for longer-run growth (1.8% to 2.0%) was unchanged.
Unemployment: Consistent with November’s payroll report, it’s believed that “labor market conditions will remain strong” even as the FOMC makes gradual adjustments to policy. The official unemployment rate has declined further, with 4.1% matching the lowest level since 2000. There was no specific mention of wage growth, but the recent 2.5% year-over-year increase in average hourly earnings is quite tepid for a maturing cycle. The Committee lowered its central tendency for longer-run unemployment to 4.4% to 4.7%, but participant projections show sub-4% readings over the next couple years.
Inflation: The statement noted again how “market-based measures of inflation compensation remain low”. The just-released Core CPI reading for November dropped back to 1.7% year-over-year, and remains toward the low end of the 1.6% to 2.3% range that has persisted since mid-2011. The Fed’s preferred measure (Core PCE) continues to trail at +1.5%. Central tendency projections were slightly lower into 2018, but the FOMC’s 2% objective is still thought to be attainable by 2019. The Committee is “monitoring inflation developments closely”, with awareness around inflation surprises.
Rate Projections: The Committee’s forward looking expectation for rates were largely unchanged. The “dots plot” continues to project three more quarter-point hikes in 2018. The longer-run central tendency increased slightly to 2.9%, even as front-end rates are anticipated to rise modestly above that terminal level by 2020. The market appears skeptical of FOMC forecasting, with implied probabilities showing just over a 60% chance of two or more hikes in the coming 12-months.
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