But, as we’ve been told repeatedly, the path of subsequent increases is more important, is expected to be gradual, and will be dependent on the progress of economic conditions, namely, continuing strength in output growth, improvements in the labor market and progress toward 2 percent inflation.
The statement and press conference following the Federal Reserve’s monetary policy setting committee, the Federal Open Market Committee (FOMC), December meeting removed any lingering uncertainty. The FOMC increased the target for the benchmark short-term interest federal funds rate by 25 basis points, from a range of 0-25 basis points to 25-50 points.
At the press conference following the meeting Fed Chairwoman Yellen emphasized that this move should be interpreted as a vote of confidence in the continuing strength of the economic recovery. The accumulated progress in a broad range of economic indicators has convinced the committee that the economy is strong enough to begin the process of monetary policy normalization.
In response to the “why now?” question Yellen acknowledged additional room for improvement in some areas of the economy, but also listed sustained economic growth, diminished labor market slack, the transitory nature of the headwinds inhibiting more progress on inflation, and the lags associated with monetary policy adjustments as justifications for beginning now. And the expected gradual pace of subsequent increases suggests it is more prudent to get started than wait at this point.
Yellen deflected questions aimed at identifying specific benchmarks or markers that would trigger the next increase, repeating the mantra that a broad range of economic and financial market conditions would factor into the path of increases, and that no single, simple or mechanical rule would govern the course; a sluggish or interrupted ongoing recovery would motivate a slower pace of increases than a more rapid expansion. The policy objective is to bring interest rates out of crisis mode and back to normal in a manner that doesn’t impede economic performance.
As to what markets, households and consumers should expect, Yellen offered continued economic and labor market improvements, accelerating wage gains, higher returns on deposits, and yes, slightly higher borrowing costs. A strengthening economy will bring a range of benefits and the gradual pace of rate increases will make the pain of adjustment minimal. Short term rates will move up modestly, longer term rates (including fixed rate mortgages) even less so.
The much anticipated and highly communicated liftoff has happened. Let the journey to the seemingly far off planet of normal begin.