U.S. Fed hikes rates by 25 bps, to start normalization of balance sheet later in 2017

The Federal Open Market Committee hiked the target range for the federal funds rate by 25 basis points to between 1 and 1-1/4 percent. The Committee also expects to start normalization of the balance sheet later in 2017, having outlined a plan to slowly reduce its holdings by tapering reinvestments in its Treasury and MBS portfolio. The Fed expects to cap runoff at USD 10 billion per month initially before raising it to USD 50 billion per month in a year with the same 60/40 split between UST and MBS.

The Committee was slightly positive on the economy, implying that activity has been “rising moderately” while the labor market “continued to strengthen” as job gains “moderated but have been solid” and jobless rate dropped. The statement underlined consumer spending has accelerated recently, while business investment continued to expand. The committee also viewed inflation as having “declined recently” while the core measure is running slightly below 2 percent, but expected to stabilize near the target over the medium term. Meanwhile, inflation expectations were seen as little changed and still low.

The FOMC lowered its unemployment projections by 0.2 to 0.3 percentage points through 2019, expecting the jobless rate to average 4.3 percent in 2017 and 4.2 percent in the subsequent two years, with the Committee’s view of unemployment in the longer-term 0.1 percentage point lower at 4.6 percent.

The Committee also revised down its near-term inflation outlook, lowering its 2017 average for PCE and core PCE deflator by 0.3 and 0.2 percentage points, respectively, given the weaker data to date. GDP projections were a bit higher at 2.2 percent for this year; however, they stayed the same for 2018 and 2019 at 2.1 percent and 1.9 percent, respectively.

The Fed is expected to pay quite close attention to inflation figures in the future. If the low jobless rate starts to generate the expected wage and inflation gains, another rate rise is quite possible later in 2017, noted TD Economics in a research report. But if inflation continue to slowdown, the Fed might pare back its rhetoric and likely further cut its projections for the natural jobless rate, added TD Economics.