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Market Update

Fed Sees Economy on Moderate Pace; Forecasts Rates at 3% by end of 2019

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March 15, 2017

(Wednesday, post-Fed announcement) In what the futures markets appeared to see as a foregone conclusion, the Federal Reserve raised interest rates this afternoon for the third time in a decade and indicated there are likely two more hikes on this year’s horizon.

The Central Bank moved the federal funds rates to a range of 0.75%-1%, bumping it up 25 basis points. Some moderate changes were made in its statement, but it said it was on track to continue to lift rates in quarter-percentage-point increments twice before the end of the year.

In her press conference after the announcement, Chair Janet Yellen said that the Fed has not reassessed its outlook on the economy, which it still sees expanding at a moderate pace.

Where’s the News?

As we’ve noted often, the Fed is not in the habit of shocking the markets and certainly didn’t today. The Fed said in December that this year would likely hold three hikes, but the markets, as seen through the Fed fund futures prices, didn’t necessarily buy it earlier this year. Fed governors, however, made it clear in recent weeks that March was very much, as they like to say, a “live” meeting.

That meant today’s nonevent was widely expected and the market action this week has been somewhat muted ahead of it. Immediately after the increase was announced, the three major benchmarks moved to the upside.

The Fed appeared to answer the big question looming in recent sessions on whether there would only be three hikes this year. The median forecasts from the Fed now implies rates will sit at 1.375% at the end of this year, climb to 2.125% by the end of next year and settle at 3% by the end of 2019. That’s a slight change from December, when the Fed projected the interest rate would stand at 2.9% at the end of 2019.

This suggests that the Fed will stay at this quarter-percentage-point pace until the end of 2018, but may tack on a fourth increase in 2019.

The Chicago Mercantile Exchange’s FedWatch tool, which measures the probability of rate moves in upcoming meetings, forecast a 95% probability of today’s hike only minutes ahead of the Fed announcements. The likelihood of another step up by June stood at about 60% in the first minutes after the decision was stated.

There was very little change in its statement from December’s missive, indicating that the Fed expects the economy to continue churning at the same pace it has been the last three months. The Fed did note that inflation continues to edge closer to the committee’s longer-run objective of 2% and added that “business fixed investment appears to have firmed somewhat,” changing that wording from “remained soft” in December.

The Volatility Index (VIX), the market’s fear gauge, jumped up to 12.54 Tuesday in what might have been nervousness about how aggressive the Fed might be in raising rates this year. After the decision, it had fallen below 12. 

S&P 500

FIGURE 1: UPSIDE REACTION

The S&P 500 (SPX), plotted through midday Wednesday on the TD Ameritrade thinkorswim platform, moved to the upside after the Fed inched up interest rates. Data source: Standard & Poor’s. For illustrative purposes only. Past performance does not guarantee future results.

What Rate Hike Will Cost Consumers: Credit-card debt has been steadily rising, and today’s move by the Fed to raise interest rates is likely to exacerbate that, according to WalletHub, a personal finance website. By its calculations, today’s increase will cost U.S. consumers roughly $1.6 billion in extra credit-card finance charges during 2017.

If markets react to today’s step up like they did in December, WalletHub figures mortgage and auto loan rates will edge up too. The annual percentage rate (APR) on the average 30-year fixed-rate mortgage climbed to 4.32% at the end of 2016 from 3.48% in late June. The average APR on a 48-month new-car loan stood at 4.45% in November (the most recent data available) from 4.25% in August, according to WalletHub.

A Word on the Balance Sheet: No decisions yet. That’s Yellen’s word on when the Fed will begin shrinking those purchases of long-term bonds and other assets. At her press conference, Yellen noted that the Fed plans to continue to use interest rates as its “active policy tool,” and that the balance sheet remains an option.

When will the Fed decide that “normalization” is underway? “I can’t give you a specific answer,” she said, adding that it will depend on the Fed’s confidence that the economy is continuing to improve.

And the Vote Was… One dissenter. Minneapolis Fed president Neel Kashkari, who joined the board just this year, didn’t want to move rates higher. In recent speeches, he has said he thought rates should stay steady for a little longer.

The vote count has been a point of interest among Fed watchers who keep a close eye on any dissension among the members. The thinking has been that if they don’t all agree with the chair on raising rates, then what might happen the rest of the year might be a crapshoot. Stay tuned.

Of note, too, is that today was the last policy meeting for Fed governor Daniel Tarullo, who said last month that he would retire in early April. He’s long been considered the “most influential overseer” of the U.S. banking system, according to the Wall Street Journal, and his leaving might lighten the regulatory load on banks.  

Good Trading,
JJ
@TDAJJKinahan

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