Going into Federal Reserve Chair Janet Yellen’s 32nd and final meeting, neither we nor the markets expected the Fed to make much news. Of note, however, in its statement after the meeting on 31 January, the Fed acknowledged recent firmer economic data and expressed confidence in inflation moving toward the 2% target later this year.
The macro data released since the Fed’s December rate hike has been broadly in line with the Fed’s outlook, and officials should be pleased that market pricing for policy rate normalization in 2018 is converging to the Fed’s own December “dot plot” median of three rate hikes in 2018. If that path is realized, it would place the federal funds rate just north of the Fed’s 2% inflation target and in the range that PIMCO has called “The New Neutral.”
A hike at the next Fed meeting in March ‒ which will be the first for incoming Chairman Jerome Powell ‒ is largely reflected in market pricing, and today’s statement did little to change that view.
Slightly higher inflation expected
However, the Fed’s statement noted that inflation “is expected to move up this year and to stabilize around the committee’s 2 percent objective over the medium term;” the previous statement had forecast that inflation would “remain somewhat below 2 percent.” The Fed’s outlook on household spending and business fixed investment were both upgraded to “solid.” The outlook remained unchanged as “roughly balanced” and employment gains also unchanged as “solid.”
As in December, today’s statement omitted any reference to the Fed’s ongoing program of balance sheet reduction, which has been well-communicated and in operation since October. As then Fed Governor Powell indicated in his confirmation hearings, he fully expects this program to continue and the balance sheet to continue shrinking for some time to come, until it is no larger than necessary to support the demand for currency and the bank reserves needed for the current operating system to function smoothly.
So the Fed today reinforced the case for a hike in March and two more later this year, which likely suits Chair Yellen ‒ and soon-to-be Chairman Powell ‒ just fine.