Fed Policy: Still behind the Curve 

Published On : 03/17/2017

Even while hiking interest rates today, the Federal Reserve Board maintained its dovish sentiment. In recent weeks, Fed members began signaling that rate hikes would come sooner, raising expectations for a more hawkish Fed stance. Despite the rate increase, the Fed maintained its emphasis on the need for accommodative policy and gradual rate increases even as the US economy has essentially achieved the Fed’s key targets for GDP growth, inflation, and unemployment. In fact, since their rate hike in December, US financial conditions have eased.  The short end of the curve still offers negative real yields despite full employment, above trend growth, and rising inflation conditions. And the economic stimulus promised by the Trump administration has already started to take effect through executive orders rolling back regulations and supporting investment. Given these clear improvements and the upward trajectory of both the US and global economies, the Fed risks falling further behind, potentially requiring greater rate increases in the future that could destabilize the markets and economic growth.

The Fed raised rates 25 basis points (bps), as they had clearly signaled. Markets were on balance surprised because many had come to expect that the Fed would increase rates four times in either 2017 or 2018. Instead, they maintained their forecast of three hikes each year. As a result, bond markets rallied, with the 10-year Treasury falling by 10 basis points (bps), and the US Dollar falling by over 1%.  In her press conference, Chair Janet Yellen took pains to emphasize that the Federal Reserve would take a gradual approach to rate increases.

Strong GDP and Employment

While first quarter GDP growth may reflect a seasonal decline from fourth-quarter GDP, combined with materially delayed seasonal tax refunds, forward-looking indicators suggest strong US GDP growth. Initial jobless claims remain at over 40-year lows.  Both ISM manufacturing and non-manufacturing indices are well into expansionary territory, with strong new orders and employment components.  Should employment continue to surprise to the upside, wage inflation may begin to accelerate.  At 4.7%, the unemployment rate stands below estimated NAIRU (non-accelerating inflation rate of unemployment), which refers to a level of unemployment below which inflation rises.

Financial Conditions Have Eased Since Last Tightening

US and global financial conditions have eased recently, despite the Fed’s December rate increase. While part of the Fed’s concerns in the past have centered on global growth, now that global purchasing manager indices (PMIs) have turned positive, supported in part by easy financial conditions, this factor may not be significant to their decision-making process in 2017.

Wanda Rich

Wanda Rich has been the Editor-in-Chief of Global Banking & Finance Review since 2011, playing a pivotal role in shaping the publication’s content and direction. Under her leadership, the magazine has expanded its global reach and established itself as a trusted source of information and analysis across various financial sectors. She is known for conducting exclusive interviews with industry leaders and oversees the Global Banking & Finance Awards, which recognize innovation and leadership in finance. In addition to Global Banking & Finance Review, Wanda also serves as editor for numerous other platforms, including Asset Digest, Biz Dispatch, Blockchain Tribune, Business Express, Brands Journal, Companies Digest, Economy Standard, Entrepreneur Tribune, Finance Digest, Fintech Herald, Global Islamic Finance Magazine, International Releases, Online World News, Luxury Adviser, Palmbay Herald, Startup Observer, Technology Dispatch, Trading Herald, and Wealth Tribune.