Fed Finally Pulls the Trigger

After signaling for months that it would raise the federal funds rate in December, the Federal Open Market Committee did just that yesterday.

Following its two-day policy meeting, the FOMC yesterday raised the federal funds rate by a quarter point to between 0.50 and 0.75 percent. It marks the first time the FOMC has raised the federal funds rate since last December and only the second time since 2008.

In raising rates, the FOMC cited an expanding economy. “The labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year,” the Fed said. “Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft.”

And Federal Reserve Chair Janet Yellen, in a news conference following the meeting, indicated that could be just the start, suggesting that the Fed could raise the federal funds rate three times next year.

Mortgage Bankers Association Chief Economist Mike Fratantoni said the increase was expected and markets had already made accommodations.

“MBA had anticipated that the Fed would move to a more hawkish stance, predicting three hikes for 2017,” Fratantoni said. “The Fed’s statement and Chair Yellen’s remarks at the following press conference met this forecast, as they are now projecting at least three hikes in each of the next three years. Chair Yellen indicated that in addition to a more upbeat forecast regarding the economy, some FOMC members also incorporated into their projections some chance of a tax cut or other stimulative policy from the incoming administration.”

Fratantoni noted mortgage application volume continued to drop in response to a relatively small increase in mortgage rates. “Rates climbed following the election and appear to be up a bit following the Fed’s announcement today,” he said. “We have adjusted the forecasted path of interest rates upwards slightly in our December forecast, and expect that refi activity will continue to fall during 2017. We expect that purchase activity will be robust, backed by the strength of the job market.”

Jamie Woodwell, MBA Vice President of Commercial Real Estate Research, noted markets gave the Fed a window to resume raising the Fed Funds rate.

“The move has been so widely telegraphed, and anticipated, that it is not likely to have a significant short-term impact on borrowing rates,” Woodwell said. “The real news is in their expectations about how they will act in 2017. For commercial real estate, the increase is the latest signal that the ultra-low rates of 2016 are likely not the long-term norm, and that borrowers who have not locked-in long-term, fixed rate financing will want to be vigilant about how both short- and long-term rates move going forward.”

“In addition to the impact on existing-home sales and house prices, first-time home buyers will feel the most impact of the rate increase,” said Mark Fleming, chief economist with First American Financial Corp., Santa Ana, Calif. “When rates go up, house price appreciation slows down. That’s good news for potential first-time homebuyers. Even with the rate increases we expect to see next year, housing affordability is better than it’s been in years, when adjusted for consumer house-buying power. Even after the ‘Trump Bump’ and FOMC rate increase, 2017 will still be a good time to buy.”

The FOMC statement (https://www.federalreserve.gov/newsevents/press/monetary/20161214a.htm) appears below:

“Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year. Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft. Inflation has increased since earlier this year but is still below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 1/2 to 3/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Esther L. George; Loretta J. Mester; Jerome H. Powell; Eric Rosengren; and Daniel K. Tarullo.”