So the Fed, as expected, raised rates for the first time this year. It’s arguable whether the Fed should have raised rates given the ongoing low inflation, strengthening USD and modest growth in wages. And let’s not forget there is a high uncertainty about what the new Trump administration will do in terms of fiscal policy and how it will affect the U.S. economy. The big surprise –as much of a surprise as the Fed could pull at this point – was the rise in the trajectory of the Fed’s cash rate, as indicated in the table below.
Source: Federal Reserve
Also in the press conference Chair Yellen sent mixed signals: The rise in the cash rate as indicated in the dot plot is of only 0.25 bp, all awhile rates she isn’t keen of overheating the economy. But in end the markets raised their projections of the cash rate trajectory in 2017 to 2-3 rate hikes. This is the first time in a long while the Fed is in line with the market expectations. Recall, the Fed expected four hikes in 2016 back in December 2015 while the markets priced in 2 hikes. And perhaps this is one of the main reasons the Fed revised up its cash rate for 2017: The FOMC prefers to be ahead of the curve and not push up the dot plot too soon and too fast if inflation does pick up. Another factor to consider is that the dot plot voices the opinion of its members if they were in charge. So the few hawks in the Fed could revise up the cash rate outlook even if the majority and – more importantly – the Fed Chair think that the cash rate isn’t likely to rise more than twice next year, which currently seems a more likely scenario.
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