After raising interest rates for the first time in seven years on December 16, 2015, roughly a year later, the Federal Open Market Committee (FOMC) unanimously decided to raise the target Fed funds range, this time by another 25 basis points to a range of 0.50-0.75bps. This marks only the second rate increase in the decade and is reflective of the sluggish economic recovery. While this is a notable event, the move by the Fed had been telegraphed and was widely expected by the market. 

Accompanying the hike in rates, new projections show the Federal Reserve now expects three 25 basis point rate hikes in 2017, which is up from their previous guidance of two. The drop in the unemployment rate from 4.9% to 4.6% in November, the lowest rate since August 2007, was one factor driving the upward revision in projections. In addition to lower unemployment, inflation expectations have also increased. Some FOMC participants also factored in higher fiscal spending into their outlook, which contributed to the increase in projected hikes from two to three.  

The market had expected Chair of the Federal Reserve Janet Yellen to remain dovish, yet comments made during the press conference were interpreted as hawkish. In addition to stating that the labor market would likely reach full employment without fiscal stimulus, Yellen also indicated that monetary policy was on course to achieve its 2% inflation target.  

There is room for the Federal Reserve’s interest rate projections to be revised upward. To preserve political objectivity, the Federal Reserve does not include President-elect Trump’s fiscal stimulus plan into its projections. Implementation of the new administration’s agenda may spur higher growth and inflation which would ultimately push rates upward. Through a combination of tax cuts, government spending and deregulation, the new administration is targeting a goal of 3% to 4% GDP growth. While Mr. Trump has strong conviction on passing a robust fiscal spending package, the devil will be in the detail. The size and the scope of the fiscal stimulus plan could be slimmed down by political and budgetary realities.

The recent and sudden rise in longer term rates has come after the 10-year U.S. Treasury note hit an all-time low of 1.36% on July 8, 2016, post Brexit vote, and stood just below 1.80% on election night. Shortly after the Federal Reserve decision, the comparable rates have increased to 2.60%. 

While this December hike is analogous with last year’s December hike, we believe that there is a stronger likelihood that the Federal Reserve will follow through with additional hikes in 2017 and the July 8th all-time lows likely hold. Entering 2016, four rate hikes were penciled in. Those expectations were quickly dashed as the equity market swooned in January due to concerns related to slowing growth in China, negative interest rates and plunging oil prices. While a macro-economic shock could again throw the plan off course, the Federal Reserve is closer to achieving its dual mandate of maximum employment and price stability.