Federal Reserve Monetary Policy

 Fed Raises Short-Term Interest Rates 25 Basis Points As Expected

  • The Federal Reserve raised the target range of the fed funds rate by 25 basis points.
  • The new Dot Plot remains consistent with three 25 basis point rate hikes in 2017 and 2018.

As widely expected, the Federal Open Market Committee voted today to increase the fed funds rate range by 25 basis points, to 1.00-to-1.25 percent. The economic commentary in the monetary policy announcement was slightly more positive than the May 3 statement. A key economic issue for the Fed is recently moderating inflation, which may call into question the Fed’s plans for further interest rate increases. However, in the material issued today by the Fed, we see an FOMC moving ahead, not yet ready to back off plans for one more rate hike this year, and three more next year. There was one dissenting vote from today’s policy action. That was from Neel Kashkari, President of the Federal Reserve Bank of Minneapolis. Today’s policy announcement was accompanied by a new set of economic projections, a new “dot plot” and an addendum to the Fed’s previously published Policy Normalization Principles and Plans, which provides some added detail about balance sheet reduction.

In their new economic projections, FOMC member’s median projections of real GDP growth for 2017, 2018 and 2019 were little changed from the projections of March 15, at around 2 percent per year. The unemployment rate projections were lower, dipping to 4.2 percent in 2018, reflecting the faster-than-expected drop in the unemployment rate this year. Long run inflation projections were unchanged at near 2 percent. This is an important point because it shows that the FOMC currently sees justification for more rate hikes even though inflation indicators have recently been weak. The median expected year-end fed funds rates for 2017, 2018 and 2019 were essentially unchanged from March 15.

Likewise, the new dot plot is little changed from March. It remains consistent with one more 25 basis point rate hike this year and three 25 basis point rate hikes in 2018. Expectations for the long-run fed funds rate remain centered around 3 percent.

The addendum to the Fed’s policy normalization principles gives us a little deeper view into balance sheet reduction. Once the program gets started, the Fed will continue to reinvest maturing assets only to the extent that the dollar total exceeds gradually rising caps. So the cap represents the amount of asset reduction per month. The Fed expects to start the cap on the reinvestment of maturing Treasury bonds at $6 billion per month and increase that in steps of $6 billion per quarter over 12 months until it reaches a final cap of $30 billion per month. The cap on the reinvestment of agency debt and mortgage-backed securities will start at $4 billion per month and increase in steps of $4 billion quarterly over 12 months until it reaches $20 billion per month.

In her post-policy-announcement press conference, FOMC chairwoman Janet Yellen said that the Fed had not yet determined the final size of the balance sheet, but that it would be larger than the roughly $1 trillion size that it was prior to the financial crisis. She also declined to say how long it would take to get there. She described the balance sheet reduction plan as working in the background while fed funds interest rate policy would remain the primary mechanism for monetary policy changes. Yellen would not say specifically when balance sheet reduction will start, but she reinforced previous Fed statements suggesting that it will start before the end of this year. She made her most forceful comment yet on the starting point for balance sheet reduction saying that it would happen “relatively soon.”

Market Reaction: Equity prices dipped at the start of Yellen’s press conference and then recovered. The 10-year Treasury yield increased after 2 pm eastern time to about 2.14 percent. NYMEX crude oil fell earlier today to $44.75/barrel. Natural gas futures eased to $2.94/mmbtu.

For a PDF version of this Comerica Economic Alert click here:  FOMC_06142017.

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