The Federal Reserve has increased its interest rate by 25bp. The fed fund rate will be in a corridor going from 0.75 to 1%. Previously and since last December Fed’s meeting the corridor was 0.5 to 0.75%.
The US central bank will continue to increase its rate and expects two other increases in 2017 to 1.375% (mid-corridor). Three hikes are expected for 2018 to 2.125% and for 2019 the rate will converge to 3% (which is also the Fed’s long term target). For 2017, there is no acceleration when the profile is compared to what was expected in December.
The Fed perceives the US economy as robust. Yellen said that clearly when she answered a question during the press conference. The US central bank said that its two objectives are almost attained. Growth is robust and the inflation rate is close to 2%. That’s a good reason for the central bank to increase its rate. It’s a new step for normalisation.
Growth and inflation forecasts are unchanged when compared to December. GDP growth is expected at 2.1 in 2017 and 2018 (it was 2% for 2018 in December). The inflation rate is at 1.9% and 2% as is the core inflation rate. These are the same numbers than in December.
1 – The Fed wants to have more margins to manage its monetary policy. It wants to be able to react in case of a negative shock. That’s the reason why Fed’s members have shouted this increase since last December. The central bank didn’t want to create a surprise for investors. It doesn’t want to create the risk of a shock on financial markets.
2 – The Fed doesn’t want to be perceived as constraining the economy. That’ s not the reason for the rate hike now and in the near future.
3 – The inflation rate is perceived as being on its target. The Fed now have a symmetric view of inflation. This latter can go a little above or a little below the target (2%) without creating an issue. This change in the wording reflects that the Fed is now on the target.
4 – Nothing has been said on the management of the Fed’s balance sheet. But this the next important step in the monetary policy normalisation. In the press release it is said that the Fed will continue to reinvest the proceeds of its portfolio. But in a future that is not too far, the central bank will stop this reinvestment process. It will start when the FOMC will consider that the fed funds rate is high enough (what is high enough is fuzzy of course). Yellen said that this will be done in a smooth manner. It will be important for the fixed income market as the Fed will reinvest USD 425bn in 2017.
5 – The last point is related to Janet Yellen. Her mandate as president will stop on February the 3rd 2018. She will still be at the board until January the 31st 2024 but I can’t imagine that D.Trump could propose her as president for a four year mandate.
D.Trump will name a new president. We don’t know who he can be. But he will probably be close to Trump’s ideas. The Fed could become hard to manage. Moreover, Republicans expect to limit the Fed independency. 2017 will be fascinating to follow Fed’s meetings and dicussions as we can expect a lot of balance of strength with the 3 news members that will arrive in coming months (2 are vacant and Tarullo is leaving in April.
We can imagine that Yellen will push the Fed on the best trajectory before this change. This strategy will be fascinating to follow.