As predicted, the Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points (bps), now 1.00% to 1.25%. The FOMC also set expectations that there will likely be another rate increase before the end of the year. This future rate increase is based on actual economic data meeting the FOMC’s projections.
Federal Reserve officials believe that economic growth this year will finish at 2.2%, an upward revision from their forecast for the year in March of 2.1%. They are also optimistic about the labor market. Unemployment is expected to end this year at 4.3%, down from their estimate in March of 4.5%. It is also their belief unemployment could fall further in 2018. Inflation is expected to decline to 1.6%, off from their projection in March of 1.9%. The annual target is 2%.
The other issue on the table is the question around the financial assets sitting on the balance sheet of the Federal Reserve. The Federal Reserve currently holds about $4.5 trillion in Treasury and mortgage securities. The FOMC signaled to the markets that they expect to reduce their balance sheet in a “predictable” manner and that the amount of reduction would be “sizeable.”
This change in the federal funds rate and the language surrounding future asset sales was largely predicted and priced into the markets. The Chicago Mercantile Exchange publishes the implied probability of a change in FOMC policy rate. Going into the meeting on June 13 and 14, the futures markets had been priced which equated to a 94% probability of a change in rates by 25 bps. The futures markets are now predicting a 40% chance of another 25 bps rate hike before the end of the year, most likely at the December 13 FOMC meeting. This, however, is down from earlier readings when the implied probability was at 50% of another 25 bps rate hike before year-end.
What is most interesting about the rate hike today is how the markets have reacted. In particular, the rates for 10-year U.S. Treasury bonds have declined. Not by a lot… The yield on 10-year Treasuries ended June 14 at 2.13%, down 0.02%. As a reminder, 10-year Treasuries hit 2.6% shortly after thepresidential election. Since the election, the FOMC has raised rates by 50 bps, but the yield on 10-year Treasuries has declined by an equal amount. This flattening of the yield curve may indicate the market’s opinion of a general underlying weakness in the economy, which is different from what the FOMC statesas their expectations.