The Fed finally hikes rates – what does it mean?

The U.S. Federal Reserve (Fed) hiked rates 0.25% today, for only the second time in this cycle, to a range of 0.5% – 0.75%. The statement that accompanied the meeting made note of a strengthening of the labour market, moderate growth and improving inflation. Additionally, the Fed views risks to the economy as “roughly balanced”.

The surprising market optimism since the election of Donald Trump as President of the U.S. left the Fed with little choice but to raise the target rate range, in my view. Yields on the 10-year Treasury have increased 0.71% since the election¹ as expectations for future fiscal policy stimulus, individual and corporate tax cuts and reductions in regulations have generated a spike in inflation expectations.

The Fed’s summary of economic projections showed modest improvement in the expected change in GDP growth and the unemployment rate in the U.S. Probably the most surprising change by the individual Fed members was the increase in future rate hike expectations from two to three hikes in 2017.

The Fed’s statement indicated that economic conditions will likely “warrant only gradual increases in the Federal Funds Rate”, although Fed Chair Janet Yellen did not emphasize that issue during her press conference. In our view, the Fed will most likely remain somewhat cautious until the new administration is in place and has put more specific policy proposals on the table.

The next Fed meeting is scheduled for February 1, 2017. However, at this point, I would not expect another rate hike to occur until after the first quarter of 2017.

At Invesco Fixed Income, we believe today’s statement should be viewed as neutral to slightly negative for equity and bond prices as the Fed was slightly more hawkish than we had expected. In addition, I believe this announcement will be reflected in a stronger U.S. dollar.