As expected, the Fed increased rates by 25 bps and continues to project two additional rate increases for this year.
Policy Normalization on Target: In a unanimous vote, the FOMC voted to raise the target range for the Fed Funds rate to 1.5% to 1.75%. This 25bps 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 October will increase its pace in April. Principal payments will be reinvested only to the extent that they exceed higher caps. For U.S. Treasuries the new level becomes $18 billion/month (from $12 billion), and for Agency MBS the threshold goes to $12 billion/month (from $8 billion).
Growth: The official statement indicated that “economic activity has been rising at a moderate rate” and that the “economic outlook has strengthened in recent months”. Median GDP expectations for 2018 and 2019 were all revised higher, with 2018’s projection of 2.7% a 20 bps increase and 2019’s projection a 30bps increase. 2020 and longer remained at 2.0% and 1.8% respectively. In his first post-meeting press conference, Chair Powell doesn’t see recession in the near term, Powell also indicated uncertainty in the impact on the economy of the recent federal tax and spending legislation. Though financial stability risks are currently moderate, one area of focus is the elevated level of some asset prices.
Unemployment: Consistent with recent payroll reports, it’s believed that “labor market conditions will remain strong” even as the FOMC makes gradual adjustments to policy. The official unemployment rate has remained at 4.1% matching the lowest level since 2000. There was no specific mention of wage growth, but the recent 2.6% year-over-year increase in average hourly earnings remains tepid for a maturing cycle. The Committee lowered its central tendency slightly for longer-run unemployment to 4.3% to 4.7%, and sub-3.8% readings over the next few years.
Inflation: The statement noted again how “market-based measures of inflation compensation have increased… but remain low”. The just-released Core CPI reading for February remained modest at 1.8% 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 raised slightly for 2018 through 2020, with the FOMC’s 2% objective still thought to be attainable by late 2018 or 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 two more quarter-point hikes in 2018. The longer-run central tendency remained at 2.9%, even as frontend rates are anticipated to rise 0.5% above that terminal level by 2020. The market is consistent with FOMC forecasting, with implied probabilities supporting two more hikes in 2018.
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