Fed Shocks No One and Raises Rates

Key Points

  • The Fed raised the federal funds rate by 25 basis points and now expects three additional hikes in 2017.
  • The Fed noted the "considerable" rise in inflation expectations and combined with the higher "dots plot" in 2017, the statement was seen as more hawkish than expected.
  • Next year could be a year when the Fed’s expectations (dots) actually resemble reality, which was not the case in 2016.

The Federal Reserve surprised no one today and the vote was unanimous. The Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points—to a range of 0.50-0.75%—for the first time this year; having raised rates initially a year ago at this same time. The Fed also raised the discount rate to 1.25% from 1.0% and the rate paid on required and excess reserves to 0.75% from 0.5%. Also moving up were the Fed's expectations for the trajectory of rate hikes in 2017; with three additional hikes expected in 2017, up from two last September (based on median estimates of FOMC members).

The gross domestic product (GDP) and employment data within the Summary of Economic Projections all improved slightly, while the outlook in the statement was generally an upgrade from September's. In general, the change in expectations for next year were seen as evidence of a slightly more hawkish Fed.

"Considerable" inflation pressures?

Of note in the accompanying statement was the use of the term "considerably" to describe the increase in inflation expectations; and the mention of tightening labor conditions. The Fed said monetary policy supports "some further strengthening in labor market conditions and a return to 2 percent inflation." The addition of the word "some" was seen as an indication that there will be more muted improvement in job growth next year; while "strengthening" replaced "improvement" from the Fed's September statement.

Although expectations for future rate hikes lifted, the Fed's statement did repeat verbatim the language about the pace of rate hikes: "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."

Dots plot thickens

Below is an updated chart of the so-called "dots plot" which shows where members of the FOMC think interest rates will (or should) be in the next few years. The solid lines represent the current projections and the dotted lines represent the prior projections as of September.