US Fed delivers a hiked rate of 25 BPS, meets the expectations

The US Fed did it again! The Fed during its two-day monetary policy meeting, which ended on the 14th of December, 2016 raised the interest rates by 25 BPS in the range of 0.50%-0.75%, this was in line with the broader expectations of the markets, economists and analysts across the globe. Notably, this was the second-rate hike by the Fed in past decade following a similar increase in December last year. 

The central bank in its policy statement mentioned that the labour market conditions are strengthening and the economic activity is consistently enhancing in the US. Televisory, in its recent blog on the Fed’s monetary policy, stated how the US economy has gained traction in the second half of 2016, with major economic indicators on employment, inflation, manufacturing, services, consumer confidence along with housing and construction depicting an improvement. The Fed rate hike was led by the key rationale of positivity among the broader indicators, mainly the employment and inflation data. The Fed chair, Janet Yellen in her post-policy press conference said, “Our decision to raise rates should certainly be understood as a reflection of the confidence we have in the progress the economy has made and our judgment that that progress will continue. It is a vote of confidence in the economy.”

Fed economic projections-median expectations (Dec. policy v/s Sep. policy)

The action did infuse volatility in different asset classes with the US Dollar Index mounting to multi-year highs while equities in the US too continue to hover near the record levels. Emerging market equities and currencies suffered while among the commodities and precious metals, mainly, gold slipped by 1-2% during the policy week. 

Daily changes in different asset classes (Fed policy week)

Further, in the policy, one of the major surprises for markets came in the form of the dot plot wherein, the Fed increased the expectation on rate hike to 3 instead of 2 times for 2017, this was a deviation from the earlier stance. This infused positivity and projected a more hawkish outlook from the Fed, backed by anticipating optimism on the US economy. However, it should be noted that dot plot is just an estimate of how the Fed members perceive interest rates in the future and this is not necessarily a reflection of the ground realities. 

Federal funds target rate-actual/projections in different policies since mid-2015

The above table clearly indicates the projected interest rates by Fed members, although policy after policy, they moved away from their projections in 2015 and the same trend nearly followed in 2016. There was a difference in projection vs. actual action, this was due to the change in economic conditions. As per the December 2016 policy, a huge variance was witnessed over actual policy rate of ~0.6% as compared to ~1.4%, this was expected in December 2015. This was mainly owing to the unexpected slowdown in the economic growth in the first half of 2016. Thus, taking the same aspect into consideration, a policy action in 2017 would primarily depend on the continuation of the positive cues from the US economy.

Moreover, one major aspect which the Fed failed to take into account in its current projection was the much talked about fiscal boost and tax cuts, these may be planned by Donald Trump, the president-elect of the US, who will be in the office in January 2017. The “Committee for a Responsible Federal Budget”, a nonpartisan group that advocates debt reduction, stated in its September report that the US government’s debt would shoot up in the next decade. This is due to the cut in taxes and other government revenues coinciding with the increased infrastructure spending as proposed by the president-elect. While, the world waits for the clarity on Donald Trump’s policies, the next major game changer in terms of the monetary policy would be the Fed’s March 2017 meeting wherein, people would get to know the next set of policies and economic expectations from the world’s largest economy.

Also Read:- Fed’s December policy meeting, is another rate hike inevitable?

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