Fed Raises Target Range, Communicates More Hikes in ’18 but Fewer in ‘20

As was widely expected, the Federal Open Markets Committee (FOMC), the monetary policy making arm of the Federal Reserve, raised the target federal funds rate to a range of 1.75 percent to 2.00 percent from a range of 1.5 percent to 1.75 percent. Going forward, the median projection of the federal funds rate at the end of this year rose, but the median expectation for the number of rate hikes in 2020 was offsetting, so that, by the end of 2020, the median expectation for the federal funds rate was unchanged.

Today’s decision to raise the range of the target federal funds rate largely reflects strengthening in the labor market, both the increase in jobs and the falling unemployment rate. Household spending has picked up and business fixed investment continues to grow strongly. At the same time, the FOMC noted that inflation, both overall and core inflation, have moved close to two percent.

Despite the decision to increase the target rate today, the FOMC still believes that the stance of monetary policy remains accommodative. Labor market conditions should continue to strengthen and inflation should return to two percent on a sustainable basis.

The FOMC also released its Summary of Economic Projections which capture, anonymized, economic projections of Federal Reserve Board members and Federal Reserve Bank presidents under their individual assessments of projected appropriate monetary policy. These projections are released every three months and provide “forward guidance” about the views of the FOMC.

The chart above, a histogram illustrating the distribution of expectations for the federal funds rate across Board members and Bank presidents in both March and June 2018, indicates that the number of respondents expecting the federal funds rate to reach a mid-point of 2.125 percent, one more rate hike this year, fell from six to five, while the number expecting the mid-point to reach 2.375 percent, two more rate hikes this year, rose from six to seven. At the median of respondents, the expectation for the federal funds rate rose from 2.125 to 2.375 percent, or from three total this year to four.

The reason likely reflects an upward revision to the median rate of economic growth in 2018, from 2.7 to 2.8 percent and, at the median, a decline in expectations for the unemployment rate from 3.8 to 3.6 percent. The relationship between economic growth and the labor market is captured by Okun’s Law. In addition, and consistent with an expectations-augmented Phillips Curve, the decline in the median expectation for the unemployment rate at the end of 2018, coincides with an expectation, at the median, of faster inflation.

In 2019, the median projection for the mid-point of the target federal funds rate rose from 2.875 percent in the March iteration to 3.125 percent in June. If the FOMC follows the median expectation in 2018 and 2019, then the number of rate hikes, presuming they are all 25 basis points, in 2019 remains the same at three.

Although the median expectation for the federal funds rate increased in 2018 and filtered to a higher median rate in 2019, it remains the same in 2020 at a mid-point of 3.375 percent. Assuming all the hikes are 25 basis points, then FOMC projections communicate one more rate hike in 2018, but one less in 2020 so that the total number of rate hikes by the end of 2020, the longer path of the federal funds rate, remains unchanged. However, the figure above indicates that one fewer respondent expects the mid-point to be 3.375 in 2020 and an additional respondent expects it to be higher by the end of that year. While the median expectation for the federal funds rate in 2020 remains unchanged, there appears to be upward pressure on the median expectation for the federal funds rate in 2020.

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