The U.S. Federal Open Market Committee (the Fed) raised the target Fed Funds Rate by 0.25% to a range of 1.25%-1.50% at today’s meeting. This is the third rate hike this year, although the first one since the Fed announced it was reducing the size of its balance sheet at the September meeting.
The balance sheet reduction will continue as previously communicated with reinvestment declining by $10 billion this quarter ($6 billion in Treasuries and $4 billion in mortgages) and with the total reduction rising by $10 billion each quarter, until the total reaches $50 billion ($30 billion in Treasuries and $20 billion in mortgage) at the end of 2018.
The Fed’s statement recognized continued strength in economic activity as well as the strong employment picture in justifying the rate hike. The Fed also acknowledged that inflation remains below its target rate, but it is confident that inflation will recover over the medium term. Fed Presidents Charles Evans and Neel Kashkari voted against the rate hike and preferred to leave rates unchanged. Neither will be voting members of the Fed in 2018.
The summary of economic projections included several changes that recognized the strength in the economy. Real GDP growth for 2018 was revised up to 2.5% from 2.1%. The unemployment rate was revised lower by 0.2% every year, bottoming at 3.9% in 2019. There were no changes to the projections of inflation. The Fed Funds Rate projections remained unchanged in 2018 and 2019 while being revised up 0.2% to 3.1% in 2020. The long-term Fed Funds Rate remained unchanged at 2.8%. The market has priced the next Fed rate hike in March 2018.
At Invesco Fixed Income, our view is that this rate hike will not affect the positive global growth story that has been in place for most of this year as financial conditions remain easy. Given the lack of inflation, the gradual pace of rate hikes should continue to be positive in the short term for both stocks and bonds.