Stocks extended tentative gains Wednesday after the Federal Reserve bumped up key short-term interest rates for the first time since 2006, a welcome vote of confidence in the U.S. economy. The Fed also emphasized its willingness, so far, to slowly wean Wall Street and Main Street off ultra-low borrowing conditions.
The Fed noted an improved, and still improving, job market, and sees balanced risks to the economic outlook. Members said they currently expect the pace of economic growth to “warrant only gradual increases in the federal funds rate” and that rates could remain historically low for some time. Read the Fed’s full statement. The doves had their say: the statement emphasized below-target inflation.
The much-debated move to nudge the Fed funds rate up from essentially zero to a range of 0.25% to 0.5% has implications for most personal and corporate lending. And it confirms that the Fed is moving in an opposite direction than other parts of the world, where slow growth has forced central bankers to leave easy borrowing conditions in place long after the globe emerged from recession. As such, Wednesday’s move drove the U.S. dollar higher for a potentially deeper drag on crude and other commodities prices. The benchmark 10-year Treasury note added nearly 4 basis points, to 2.307% in the immediate wake of the Fed announcement. Stocks, for their part, clung to mild gains (figure 1). Notably, the late week includes the potential added volatility of “quadruple witching”—the expiration of futures and futures options on top of stock and index options.
Read the Dots?
Some industry analysts have speculated that historically low interest rates could remain in place for months or, likely, a few more years before any declaration of a return to “normal” for this stage of an economic recovery. So what exactly does that look like?
The Fed’s own so-called “dot plot” charting member expectations signals four more rate hikes in 2016, roughly one hike each quarter. At last check, short-term Fed funds futures market traders have priced in razor thin odds for a repeat hike in January but bump up that potential to 50% for the March meeting, according to pricing calculations provided on the CME Group’s FedWatch Tool.
The Fed also expects to act a bit less aggressively in 2017 and 2018 than the last time they issued this chart. The bank sees the median fed funds rate at 2.4% at the end of 2017 vs. a prior forecast of 2.6%. The 2018 target was reduced a touch to 3.3% from 3.4%.
Inflation Signals Matter
Chair Janet Yellen used a post-meeting press conference to further enlighten markets on the Fed decision, including potential clues on the scope and speed of policy moves in 2016. Her early remarks centered on her expectation that inflation-tamping effects are likely to fade.
Trading conditions may not quiet soon as markets shift to “What’s next?” for a strong dollar, weak commodities prices, and volatile stocks that are trading largely where they started the year.
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