Fed signals higher path for rates

As expected, the Jerome Powell era at the US Federal Reserve began with a 25 basis point rate hike, bringing the target range to 1.5 - 1.75 percent, a level at which the Fed considers that its policy stance "remains accommodative".

The FOMC press release says nothing very new.  Rates will continue to increase gradually, but the actual pace will as usual be determined by the data flow, and rates will "remain, for some time, below levels that are expected to prevail in the longer run".  However, the economic projections released at the same time suggest that the eventual extent of policy tightening may turn out to be greater than has been assumed until now.

To summarize: GDP growth forecasts for 2018 and 2019 have been increased marginally from the projections released in December, to 2.7 and 2.4 percent respectively.  Growth is expected to slow to 2.0 percent in 2020, but this means that growth in all three years will be above the Fed's longer-run expectation of 1.8 percent.  In a similar vein, projections for the unemployment rate have been revised lower, with the rate sinking to a remarkable 3.6 percent by 2020, well below the longer run projection of 4.5 percent.

Inflation (measured using the personal consumption expenditure deflator) is projected to edge just above the Fed's 2 percent goal by 2020, but needless to say, any faster or sharper increase would trigger a Fed response. As things stand, the median projection for the funds rate for 2020 is now 3.4 percent, 30 basis points higher than was foreseen in December.

Prior to today's release, market expectations had been that the FOMC would raise its target three times this year, including today's move.  The adjustments to the outlook for 2018 do not, in themselves, point to a need for a faster pace of tightening in the near term.  The Fed's own projections now suggest a further three 25 basis point hikes will follow in 2019, up from two such increases projected earlier.  However, if the Fed observes that the tightening labour market is exerting upward pressure on wages and inflation, the pace could be moderately faster.

One striking feature of both the press release and the data is the absence of any identifiable impact from the major tax cuts recently enacted by Congress.  However, there is no doubt that monetary and fiscal policy are now pulling in opposite directions.  Cutting taxes at a time when the economy is already operating at or near full capacity is a risky policy, one that can only make the Fed's future decisions that much more difficult.