Now on to the next one, and the next one, and the next one …
by Nariman Behravesh, Sara Johnson, and Ozlem Yaylaci
Bottom line
- As expected, the Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points at its December 13-14 meeting—the decision was unanimous.
- While the FOMC statement made no explicit mention of the anticipated boost to the economy from fiscal stimulus, the tone of the statement was somewhat more optimistic, including reference to the fact “that the labor market has continued to strengthen and that economic activity has been expanding at a moderate pace since mid-year.”
- With regard to wage inflation, the Committee said that “market-based measures of inflation compensation have moved up considerably but still are low.”
- As predicted by IHS Global Insight, the expectations of the FOMC members (based on the “dot plot”) now point to three rate hikes next year, compared with two before the November election.
- The FOMC expectations also indicate three more hikes in each of the subsequent years until an “equilibrium” rate of 3.0% is achieved—slightly higher than previous predictions.
Outlook: The pace of Fed rate hikes is set to accelerate.
The Fed is facing both a more upbeat outlook and a more uncertain policy environment. It is unclear how much fiscal stimulus will be enacted by the incoming Trump administration and Congress. That said, with the economy at or close to full employment, even with modest fiscal stimulus the FOMC projections for real GDP growth in 2017 and 2018 (2.1% and 2.0%, respectively) could be revised higher. At the same time wage and price inflation could rise even more rapidly than FOMC expectations (currently around 1.9% to 2.0% in the next two years). Thus, there is a risk that rates will have to increase even faster than the FOMC currently predicts.