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
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.
For more on interest rates and the financial markets in 2018, please
see “Putting Markets in Perspective".
Richard Clarida is PIMCO’s global strategic advisor and a frequent contributor to the PIMCO Blog.