Janet Yellen’s term as Fed chair is due to expire at the start of February © AP

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The Federal Reserve raised short term interest rates for a third time this year and predicted more increases to follow in 2018 as Janet Yellen prepares to hand over the chair amid robust hiring and surging financial markets.

The US central bank’s Federal Open Market Committee increased the target range for the federal funds rate by a quarter point to 1.25-1.5 per cent. Policymakers’ median forecast was for another three quarter-point increases in 2018 and two in 2019, even as they acknowledged inflation is continuing to undershoot their target.

Two policymakers — Charles Evans of Chicago and Neel Kashkari of Minneapolis — dissented against the decision to tighten policy, having both previously flagged up concerns about sluggish inflation.

US stocks added slightly to their gains on Wednesday and Treasury yields dropped incrementally after the news. The Dow Jones Industrial Average extended its advance from 0.4 per cent to 0.5 per cent following policymakers’ move to lift short-term rates by a quarter point to 1.25-1.5 per cent as widely expected. The S&P 500 held on to its 0.2 per cent gain at 2,669.13, while the Nasdaq Composite, which was up 0.2 per cent before Fed, traded 0.3 per cent higher at 6,884.04.

The muted moves were also seen in the bond market. Yield on the 10-year Treasury note, which moves inversely to prices, extended its decline to 3.4 basis points to 2.3707 per cent, compared to 2.3761 per cent earlier. The dollar was largely unchanged, with the DXY index hanging on to a 0.3 per cent decline.

“Today’s rate hike and the dot plot are non-events. What really matters is who is appointed to the Federal Reserve Board in 2018 and what that means for policy,” said Ronald Temple, head of US equities at Lazard Asset Management.

“In 2018, the voting membership of the FOMC changes and there are three vacant seats — four if you include Yellen’s — to be filled. These changes could materially shift the direction of monetary policy,” he added.

With the US economy at or even beyond full employment, asset prices at lofty valuations and global growth strengthening, the majority of Fed policymakers are preparing for a string of further rate increases in the coming years in spite of surprisingly soft inflation readings. Given the sturdy economic backdrop traders were already primed for a rate increase at the end of today’s Fed meeting, as well as the continuation of the Fed’s process of unwinding its quantitative easing programme.

Attention will focus on Ms Yellen’s messages about the 2018 and 2019 policy outlook when she addresses the press at 230pm eastern time. “The Committee continues to expect that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labour market conditions will remain strong,” the Fed said in a statement accompanying its rate decision.

Earlier on Wednesday Senate and House Republicans reached a tentative agreement over tax legislation that could add fuel to a recovery that is already seeing annualised growth exceeding 3 per cent and the lowest unemployment since the George W Bush era.

Fed forecasts suggested the midpoint of the Fed’s target range for interest rates is expected to reach 2.1 per cent next year and 2.7 per cent in 2019, unchanged from previous projections. It is now tipped to reach 3.1 per cent in 2020, slightly above the longer-run estimate of 2.8 per cent. The central bank upgraded its jobs market assessment, saying its policy is “supporting strong labour market conditions”, as it described growth as “solid”.

Inflation is continuing to run below 2 per cent but it should stabilise around the central bank’s target in the medium term, the Fed predicted.

The Fed is in the midst of a series of changes at the top of the organisation that will create added uncertainty over the path of policy in the coming years. Ms Yellen is due to step down as chair to be replaced by Jay Powell, one of the current governors, in early 2018, and Wednesday marks her last scheduled press conference as Fed chair.

Randal Quarles has recently come on board as the Fed’s vice-chairman for financial supervision, and President Trump is nominating Marvin Goodfriend to be another one of the governors. However further seats need filling including the vice-chair, which has been vacated by Stanley Fischer. Among the changes ahead are the retirement of Bill Dudley, the powerful president of the New York Fed, midway through next year.

One key question is whether Fed forecasts have started building in any stimulus from the near $1.5tn tax-cutting package that Republicans are attempting to rush through Congress before the end of the year.

In addition, Fed rate-setters have been divided over how to read the surprisingly tepid inflation numbers that have continued to accompany robust jobs and output growth. Core inflation measured by an alternative gauge, the consumer price index, disappointed Wall Street on Wednesday morning, suggesting the conundrum surrounding sluggish readings has yet to be dispelled.

In the central bank’s economic outlook, the median Fed policymaker predicted growth this year of 2.5 per cent, compared with 2.4 per cent in the September forecasting round, followed by growth of 2.5 per cent in 2018, up from 2.1 per cent in the previous prediction. GDP growth was tipped to be 2.1 per cent in 2019, and longer-run growth is still expected to be 1.8 per cent, well shy of the Trump administration’s 2.9 per cent growth outlook.

Fed officials now see unemployment dropping to 4.1 per cent this year, compared with 4.3 per cent in the prior forecast, and then 3.9 per cent in 2018 and 2019, compared with 4.1 per cent. The central bank’s favoured measure of core inflation was tipped to be 1.5 per cent this year, 1.9 per cent next year and 2 per cent in 2019, unchanged from the previous median forecast.

Additional reporting by Pan Kwan Yuk in New York

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