FOMC Increases Fed Funds Rate

December 13, 2017
Federal Open Market Committee (FOMC)

The FOMC increased the range on the federal funds rate

  • To (1.25% - 1.50%) from (1.00% - 1.25%)
  • The vote was 7–2 with Kashkari and Evans dissenting
  • This was the third rate hike in 2017 and the fifth since they began normalizing rates

Language Changes and Themes

  • Economic activity has been rising at a solid rate
  • Labor market has continued to strengthen
  • Inflation will remain below the Fed’s 2% target near term
  • The pace of rate increases remains gradual, which indicates that future hikes should continue to be in 25 bps increments; likely no more than one per quarter
  • Expectations are for three hikes in 2018

Market reaction

  • Front-end yields have risen across the curve in anticipation of the hike, while long-end rates have fallen, resulting in a flatter yield curve
  • Year-to-date the longer (20+ year) portion of the yield curve outperformed shorter and intermediate maturities
  • Equities markets continue to climb higher with shockingly low volatility

Conclusion

The rate hike was in line with market expectations. Relative to their benchmarks, the LIM portfolios generally benefitted as front-end rates rose in anticipation of the rate hike. Any future decision on rate hikes will continue to be highly data dependent. However, the Fed’s base case is to implement steady rate increases throughout the next year, culminating in a range of 2.00% to 2.25% by the end of 2018.

As Federal Reserve leadership transitions from Yellen to Powell, it will clearly be important to watch for any changes in Powell’s approach to monetary policy. Regardless, the Fed will continue to increasingly unwind its large balance sheet of Treasuries and mortgages, which could pressure rates higher toward the second half of 2018.  In addition, any fiscal stimulus policy initiatives would require more Treasury supply, which could also put upward pressure on rates.  If growth is stronger than anticipated, expect that the Fed will move more aggressively to increase rates. Conversely, if there is a shock to the system which causes a flight to quality, expect the Fed to delay future rate hikes until the markets normalize. In this unprecedented environment of low volatility, we see the risks as balanced for either scenario.

The information provided does not constitute investment advice, is not a recommendation, offer or solicitation to buy or sell any securities, or to adopt any investment strategy and should not be relied upon as such. It does not take into account an individual investor’s particular investment objectives, strategies, tax status or investment horizon. There is no guarantee that any forecasts contained herein will come to pass. Past performance is not an indication of future results. Investment involves the possible loss of principal. Any opinions contained herein are those of Longfellow Investment Management Co. LLC (LIM) at the time of publication and may vary as market conditions change. It is in the sole discretion of the reader whether to rely upon the opinions contained herein.