As has been hinted since September, the Federal Reserve increased the Fed funds target range by 25 bp to 50-75 bp. The market's understanding of the Fed reaction function and the communication left little doubt in the mind of investors that rates were going up Wednesday. However, there was little additional information or guidance offered. Visibility has diminished by the election and the unknown state of fiscal policy going forward.
The FOMC statement tweaked the economic assessment to reflect recent economic data. However, officials seem more confident that although growth is unspectacular it is not as fragile as it may have appeared. The Fed did recognize that the unemployment rate has declined, though in November it was little changed.
It also recognized that "market-based measures of inflation compensation," -- the yield curve and breakevens -- have moved up "considerably" and represents a new qualifier. However, the Fed still assessed these to be low. This seems to be behind the increase in the number of rate hikes that are seen as appropriate next year from two to three. The Fed Funds Futures had priced in two hikes by the end of next year. On the other hand, economists in a recent Wall Street Journal survey anticipated three hikes.
The economic projections adjustments were mild, taking growth slightly higher, although growth over the next three years is not expected to be above 2.5%. Obama is the first president since the Great Depression that has not experienced one year of his term with 3% or higher growth. Unemployment is expected to drift lower. The central tendency does not show the core PCE deflator rising above 2.0% until 2019. The median long-run Fed funds outlook was raised to 3.0% from 2.875% in September. To the extent that the long-run GDP forecast is the same as trend growth, it is notable that it was lifted to 1.8%-2.0% from 1.7%-2.0%.
The curve flattened in response to the Fed's anticipation of three hikes next year. The December 2017 Eurodollar futures yield rose 10 bp and the two-year yield rose six bp, while the 10-year yield rose 3. The dollar strengthened across the board, with the dollar moving above JPY116 for the first time in ten months. The US two-year premium over Germany jumped to almost 200 bp. The German two-year yield fell to a new record low on Wednesday.
Yellen acknowledged that fiscal policy is one of the major factors that could impact economic conditions and monetary policy. In her press conference, Yellen played down the changes to the forecast, suggesting that they were very small and reflected the changes of just a few members. She was not baited by questions about the fiscal stimulus promised by the president-elect. Yellen explained that some supply-side changes could boost growth potential and not be inflationary.