Fed Takes a Hike

The Federal Open Market Committee, to no one’s surprise, raised the federal funds rate by another quarter-point at the end of its two-day policy meeting yesterday.  

In its statement (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170614a.htm), the Fed noted the labor market “continued to strengthen and that economic activity has been rising moderately” so far this year. Inflation indicators remained stable, the FOMC said, well within the Fed’s 2 percent objective.  

The federal funds rate now stands between 1-1.25 percent.

“The outlook was slightly upgraded, with increased household spending and business fixed investment, a labor market that has continued to strengthen and economic activity ‘rising moderately,'” said Mortgage Bankers Association Chief Economist Mike Fratantoni. “There was acknowledgement of recent declines in inflation, but the committee continues to expect this is temporary and will pick up.”

The Fed also shed further light on its plan to wind down purchases of mortgage-backed securities, saying it would likely start this year.  

“The Fed will begin to reduce the securities held on its balance sheet later this year, limiting the amount of securities that will be allowed to run-off each month,” Fratantoni said. “With lower caps for mortgage backed securities compared to Treasuries, it is possible that there will be less widening in mortgage spreads than previously estimated.”

The plan emphasizes that the balance sheet will be reduced in a gradual and predictable manner. “The process will be ‘running quietly in the background’ if economic growth and inflation continues as expected,” Fratantoni said. “The statement also reaffirmed that the target fed funds rate is still the primary means for monetary policy action. Markets viewed the statement as more hawkish than anticipated, with 10 Year Treasury rates rising slightly following the statement.”

The FOMC statement in its entirety appears below:  

“Information received since the Federal Open Market Committee met in May indicates that the labor market has continued to strengthen and that economic activity has been rising moderately so far this year. Job gains have moderated but have been solid, on average, since the beginning of the year, and the unemployment rate has declined. Household spending has picked up in recent months, and business fixed investment has continued to expand. On a 12-month basis, inflation has declined recently and, like the measure excluding food and energy prices, is running somewhat below 2 percent. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.  

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee continues to expect 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 on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the Committee’s 2 percent objective over the medium term. Near term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.  

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 to 1-1/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a sustained 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. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant 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. The Committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated. This program, which would gradually reduce the Federal Reserve’s securities holdings by decreasing reinvestment of principal payments from those securities, is described in the accompanying addendum to the Committee’s Policy Normalization Principles and Plans.  

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Patrick Harker; Robert S. Kaplan; and Jerome H. Powell. Voting against the action was Neel Kashkari, who preferred at this meeting to maintain the existing target range for the federal funds rate.”