The central bank has a stated dual mandate when assessing its monetary policy: maximizing employment and stabilizing prices.
Stocks rose on Wednesday, but worries about stretched valuations and caution before a near-certain rate hike by the US Federal Reserve kept their gains in check, while the dollar steadied against a basket of major currencies. The market (according to fed funds futures) puts the fed funds rate at around 1.24% by the end of 2017 [Figure 2], close to the Fed’s own projection, and just one basis point (0.01%) lower than what the market was predicting immediately after the March rate hike. The move, to a still-low range of 1 percent to 1.25 percent, will likely lead to somewhat higher rates on some consumer and business loans.
For some perspective, the administration of former USA president Barack Obama borrowed about $9-trillion (U.S.), nearly doubling the size of the federal debt as a percentage of the economy.
It was the Fed’s third consecutive rate increase, signaling a definitive end to the Fed’s nine-year old economic stimulus scheme.
On the economic front, the Fed now expects inflation to be lower this year, but to rise to the official target of a 2% increase by 2018. In the past, when the Fed raised rates, it tended to cause interest rates on mortgages to go up too.
Even if the Fed does hike rates today, we expect there to be dissenters.
In the meantime, the shooting of Republican Congressman Steve Scalise and others at a ballpark in Virginia early Wednesday may unnerve markets.
At the time, they slashed interest rates and bought up U.S. treasuries and mortgage-backed securities to keep rates low.
“With the Fed stating its intentions to start reducing the size of the balance sheet this year, it is offering a clear vote of confidence for the economy”, said Curt Long, chief economist of the National Association of Federally Insured Credit Unions.
For TD, there’s about a 55 per cent chance that the base-case scenario plays out, and it’s partly defined by a steady path for the Fed’s median dot-plot projections, even as some of the lower forecasts potentially decline further. The bond purchases were meant to depress long-term borrowing rates as an additional way to energize the economy as it struggled to emerge from the Great Recession. But America no longer needs as much of the Fed’s medicine.
The central bank could provide more details on its plans to shrink the mammoth bond portfolio it amassed to nurse the economic recovery.
One question mark facing the Fed this year is the future of Yellen.
The Fed said it “currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated”.
Expectations of any fiscal stimulus in the near term from the Trump administration have also waned with campaign promises on tax cuts, regulation rollbacks and infrastructure spending either still on the drawing board or facing hurdles in Congress.
“The market’s expectations about inflation may be proven wrong but they would rather be proven wrong than believing whatever the hell the Fed is saying”, said Memani.