*As seen on LinkedIn Pulse*
By the time the Federal Open Market Committee met, the market had largely come to expect this increase but just a month ago had assigned a less than one-in-four chance of an increase. The Fed pulled off this feat by masterfully managing market expectations over the last six weeks, using Senate testimony, public statements, and supportive economic data such that the actual rate hike this week seemed almost perfunctory.
This rate hike raises questions highlighted below:
What impact does this have on US and global economies and markets? With the expected rate increase largely digested by US rate markets over the last six weeks, the increase is unlikely to cause major market disruption in the US or abroad. From the perspective of the US economy, this is a clear reflection that the Fed views the labor market and inflation as heating up. The unemployment rate, wage growth and other inflation metrics will be important signals to monitor going forward.
Is this a reaction to fiscal policy expectations? Unless the Fed knows something we don’t…no. Still little is known around the new administration’s proposed tax reforms, infrastructure spending and trade policies, which could influence monetary policy going forward. The Fed is not acting based on clarity of policy direction. While noting fiscal policy can have an important impact, Chairwoman Janet Yellen said, “Of course it is still too early to know how these policies would unfold. Of course, fiscal policy is only one of many factors that could influence the outlook.”
Is this the end of Federal Reserve gradualism – a key theme we identified in our 2017 Global Outlook? We maintain the Fed will stick to its approach of gradualism. Ms. Yellen was explicit in her post-meeting press conference that this first rate hike of 2017 still falls within the playbook of “gradual” and does not signal a quickening pace of rate hikes. The FOMC reaffirmed its previously stated expectation of three rate hikes—including this one—for 2017.
Can we expect the Fed to use this approach to transmit further policy shifts to through the market? In many ways, this methodical communication process was the opposite of the disruptive “Taper Tantrum” brought on by former Fed Chairman Ben Bernanke’s comments in May 2013. We think the Fed will continue its approach of gradualism and attempt to tighten monetary policy but without surprising markets by providing clear guidance of moves ahead of actually making them. The rate increases will be gradual to the extent possible. The real question is whether the pace of inflation begins to get away from the Fed, in which case it may have to shift from a methodical, gradual and clearly communicated approach to a more rapid and reactionary one. We do not expect this in the near term but a shifting inflation environment would likely force a new communication dynamic for the Fed.
We will continue to monitor the Fed and global monetary policy, along with changes to fiscal policy and look forward to continuing this conversation as events unfold.