Analysts scrutinize the statements released immediately following the meetings of the Federal Reserve’s monetary policy setting arm, the Federal Open Market Committee (FOMC) for hints about the likely direction of policy and implications for the economy. Like Kremlinologists, every adjective, choice of wording and change is examined. In the December statement only one sentence mattered: “In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent.”
The move was widely anticipated. Futures contracts based on the federal funds rate, used to hedge short-term interest rate risk (FOMC), traded at prices equivalent to a market estimation of a 95% probability of a 25 basis point increase at this meeting.
At the press conference following the meeting, Federal Reserve Chair Janet Yellen’s circuitous response to a question about the recent sharp increase in other market interest rates deftly concluded that the committee had effectively communicated their conditional inclinations, and market participants had correctly interpreted the incoming data since the November meeting, making the rising rates confirmation that the process was working well.
Yellen emphasized that this increase was a vote of confidence in the progress of economic recovery among FOMC participants, and acknowledged that recent increases in longer term rates also suggested market participants expected strong economic growth in the years ahead, perhaps based on proposed fiscal stimulus, although the details and implementation are highly uncertain, and likely to take some time to affect the path of the economy.
In response to several questions surrounding the implications of proposed fiscal stimulus and an apparent increase in the path of the federal funds rate based on the “dot-plot”, Yellen noted that the economic projections of committee members were little changed since the September meeting, the response to still uncertain fiscal stimulus would be developed as the economy’s response to any stimulus unfolded, and that relatively few meeting participants had raised their expectation of the path of the funds rate; the median projection is only 25 basis points above the September projections for year-end 2017, 2018 and 2019.
The median projection of the funds rate in the “dot-plot” indicates 3 quarter point increases in each of the next 3 years, although Yellen was quick to point out this is not a forecast or concrete plan, simply expectations based on current information and subject to change with conditions.
This was step 2 on the path to monetary policy normalization, and highly anticipated. The next steps will be taken in an economy that has recently become less certain.