Fed hikes rates, lifts economic forecast, signals two more rate hikes this year

Myles Udland
Markets Reporter

The Federal Reserve has raised interest rates for the sixth time since the financial crisis and signaled that at least two additional rate hikes are coming in 2018.

On Wednesday, the central bank announced an increase in its benchmark interest rate target range by 0.25% to a new band of 1.5%-1.75%. This move puts the effective fed funds rate at around 1.63%, the highest since September 2008. All eight voting members of the FOMC voted in favor of Wednesday’s decision.

The Fed on Wednesday acknowledged an upgraded outlook for the economy by including an entirely new sentence in its statement which said, “The economic outlook has strengthened in recent months.”

The statement noted, however, that, “Recent data suggest that growth rates of household spending and business fixed investment have moderated from their strong fourth-quarter readings.” In January, the Fed described gains in the labor market, household spending, and business investment as “solid.” The Fed also changed its characterization of job gains from its January policy statement to “strong” from “solid.”

In February, the unemployment rate stood at a 17-year low of 4.1% for the fifth straight month. In the first quarter, GDP growth hit an annualized rate of 2.5% while manufacturing, small business, and consumer sentiment surveys all continue to hold near post-crisis highs. Some on Wall Street have said these dynamics indicate this is “as good as it gets” for the U.S. economy.

The FOMC’s economic outlook

Wednesday’s release also included the Fed’s latest Summary of Economic Projections (SEP), which includes its dot plot forecast of future interest rate increases.

The dot plot released Wednesday indicates that Fed officials are split on whether two or three additional interest rate increases will be needed in 2018. Of the 15 officials offering forecasts on interest rate increases over the balance of 2018, seven expect three or more additional rate hikes while eight are calling for two or fewer.

The FOMC’s projections for interest rates.

Fed Chair Jerome Powell, who was sworn in as Fed Chair to replace Janet Yellen in early February, indicated in testimony before Congress late last month that the Fed would likely need to raise interest rates four times in 2018. Some Wall Street economists had expected Wednesday’s forecast to show the Fed increasing the number of rate hikes that would be needed in 2018 to four from three, while others felt a move higher in the dots would not come until later this year.

The dot plot also indicates that officials expect two interest rate increases will be warranted in 2019 and 2020, bringing the effective fed funds rate to 3.375% by the end of 2020. This rate is above the long-run equilibrium rate of 3% implied by the dots.

The latest SEP also shows the Fed upped its outlook for GDP growth in 2018 to 2.7%, an increase from 2.5% in its December forecasts. This is also a marked increase from the 2.1% GDP growth forecast for 2018 held by officials in September 2017. Fed officials also increased their expectations for GDP growth in 2019 on Wednesday to 2.4% from 2.1% in December.

The unemployment rate is expected to fall to 3.6% by the end of the decade according to the Fed’s latest forecasts, while inflation should hit 2.1% in 2020, above the Fed’s 2% target. The Fed’s longer-run expectations for the unemployment rate currently sit at 4.5%, down from 4.6% in December but still above both the current and expected future rates of unemployment.  

Wednesday’s projections from the Fed indicate an overall outlook for the economy through the end of the decade indicates lower unemployment, faster economic growth, and a potential overshoot of its inflation target as we enter 2020.  

The Fed on Wednesday also said it will increase the monthly caps of its balance sheet shrinkage by $10 billion per month beginning in April, bringing the total monthly reduction of its balance sheet to $30 billion from $20 billion as of March.

Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland

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