The Federal Reserve unanimously decided to raise rates in 2016 – finally! – by a quarter of a percentage point earlier today, as the markets expected. The federal funds rate is now set to hover between 0.50% and 0.75%.
In addition, the Fed slightly accelerated the pace of projected rate hikes in 2017, up to a median forecast of three hikes next year versus a prior estimate of two. After that, there was no change in the projected pace of rate hikes, with the Fed still anticipating three rate hikes each in 2018 and 2019 and an ultimate long-run average rate of 3.0%.
Meanwhile, the Fed made its statement more hawkish. First, it said "inflation has increased" versus the last statement in November, which used a wishy-washy "inflation has increased somewhat." Second, it said market-based measures of inflation compensation "have moved up considerably." Other than that, there were no noteworthy changes to the statement.
In our view, economic fundamentals warranted multiple rate hikes this year. The unemployment rate is already below the Fed's long-term projection of 4.8% and nominal GDP – real GDP growth plus inflation – has grown at a 3.1% annual rate in the past two years. Meanwhile, consumer price inflation has accelerated to 1.6% in the past year from 0.2% in the year ending in October 2015.
Given the likelihood of tax cuts next year, we think the Keynesians at the Fed will become increasingly comfortable with their projection of faster rate hikes, unlike in the past few years when they over-promised and under-delivered. Slightly higher short-term rates are not going to derail US growth. Instead, rate hikes will help prevent a misallocation of capital and problems down the road.
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist
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