The Fed Hikes Rates As Expected
US economic data keep improving at a solid pace. As expected, the Fed changed its monetary policy by increasing its funds rate by 25 bp, a first since 2006. The focus is now on the pace of the tightening cycle over the coming months.
The facts before the Fed meeting
Following encouraging signs regarding the economic environment over the past few
months, the Fed has gradually adopted a more hawkish stance to prepare financial markets for the first rate hike this year. Wage growth has been accelerating and
base effects linked to oil prices should be pushing inflation higher over the coming
months. The stable level of inflation expectation is also encouraging. After the
ECB statement of December 3rd, the US dollar fell back and is now less overvalued.
Today’s interest rate decision was thus already priced in by most market
participants. One key uncertainty, however, is regarding the future path of interest rates.
The policy announcement today
As expected, the Fed has started normalizing its monetary policy by increasing the Fed Funds rate by 25 bps, which now stands at 0.50%. Economic projections for real GDP, unemployment and inflation remain broadly unchanged.
Whereas Fed member projections suggest that rates will be about 3% higher within the
next few years, the pace of tightening is a subject of debate. In fact, the Fed could
proceed to 3 or 4 rate rises of 25 bps in the next 12 months, depending on how the
economy reacts. If economic data (inflation, USD, oil prices, employment) are lower than
expected, then a downward revision in the pace of rate hiking could be decided. In
summary, the Fed reiterated that hikes would likely be “gradual” and data
dependent. The Fed’s members interest rate projections (“dots”) moved only marginally.
The median long-run estimate was unchanged at 3.50%.
The market reactions
Financial markets had been waiting for this announcement for several months.
The market reactions were positive and suggested some relief.
- On stock markets, the S&P500 index closed +1.45% yesterday. This morning, most Asian
equities recorded positive performances while most European futures indices suggest
a positive opening.
- The Euro fell back below 1.09 compared to the dollar.
- The US 10-year rate declined a few basis points. The 2-year bond yield was broadly