Analysis of the recent Federal Open Market Committ

Two Dissents As FOMC Decides to Raise Interest Rates Again

The December FOMC decision to raise the Fed funds target rate another quarter percentage point, while widely expected by economists and the markets, reveals a chink developing in the armor of a unified FOMC.  Charles Evans and Neel Kashkari decided to vote against a rate hike this month as inflation so far has failed to lift toward the FOMC’s target.  Moreover, the revised median dot-plot was nearly identical to the one released in September, with most FOMC participants anticipating another three quarter point rate hikes next year.  Some analysts were expecting the FOMC median to signal a more aggressive rate hike path next year. 

The FOMC released a revised Summary of Economic Projections (SEP) showing a somewhat faster pace of real GDP growth through 2020 than that forecast in September.  The FOMC median now expects 2.5% GDP growth Q4/Q4 next year, up from 2.1% forecast previously.   The FOMC boosted their forecast for GDP growth by 0.1 percentage points for 2019 and 0.2 percentage points for 2020 as well.  More FOMC members are factoring in a short-term boost to GDP growth from the change in Federal tax policy. 

The labor market is expected to be somewhat tighter as a result with the unemployment rate averaging 3.9% in 2018 and 2019 - about two tenths of a percentage point lower than what was forecast in September.  

Notably, the FOMC’s median forecast for core PCE inflation was unchanged from September.   As a result, the FOMC median dot-plot of the Fed funds rate target for the end of 2018 and 2019 were unchanged from the September projections, while the long-run Fed funds rate estimate remained at 2.8%.

Yellen mentioned in her press conference that there was no need to alter the Fed balance sheet normalization program, so bond investors can expect the Fed’s balance sheet to shrink at a faster pace starting in January to $20 billion a month.  

The December FOMC statement itself was a snooze, little changed since the November meeting, though I would note that the statement around future labor market conditions was adjusted from “strengthen somewhat further” to “remain strong”.  Perhaps suggesting that labor market conditions will not materially improve from where they are today.

Bottom-line, the two new dissents on the rate hike decision today from FOMC doves revealed a growing gap on the FOMC over the implications of recent low levels of core inflation.  The FOMC median and Yellen herself stuck to their temporary factors argument, but there are definitely some FOMC members that are getting more uncomfortable with the lack of progress on bringing inflation back to the Fed’s intermediate target.  My Fed funds rate forecast is unchanged following today’s FOMC meeting.  We still look for two additional quarter point rate hikes in 2018, which remains somewhat below the current FOMC median forecast.

Treasury bonds yield dropped further following the decision.  The 2-Yr yield dropped 4.3 basis points from yesterday and the 10-Yr yield fell 5.0 basis points to 2.355%.  The dollar spot index is falling as well, down 0.64%, from yesterday’s level.  U.S. stocks held on to moderate gains today as a gradual pace of future rate hikes should keep corporate profits buoyant near-term.