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Fed Raises Interest Rates as Focus Turns to 2018 Fed Predicts Modest Economic Growth From Tax Cut
(about 4 hours later)
• The Federal Reserve, in a widely expected decision, raised its benchmark rate by a quarter of a percentage point, to a range of 1.25 percent to 1.5 percent. WASHINGTON — The Federal Reserve, buoyed by a steadily strengthening economy, raised interest rates for a fifth time since the financial crisis on Wednesday and predicted that a proposed tax cut moving through Congress would modestly increase economic growth for the next few years without stoking inflation.
• The Fed also predicted stronger economic growth over the next three years. It forecast 2.5 percent growth in 2018, well above its previous forecast of 2.1 percent growth in 2018, published in September. Janet L. Yellen, the Fed chairwoman, said the faster growth forecasts reflected an assessment of the $1.5 trillion tax cut moving through Congress. As a result, the Fed said it did not expect the legislation, which President Trump has called “rocket fuel” for the economy, to accelerate the Fed’s plans to raise interest rates in 2018 and indicated it remains on track for three rate increases next year.
• Officials did not deviate from their 2018 outlook for interest rates or inflation and continued to signal three interest rate increases next year. The Fed’s highly anticipated economic assessment, delivered after a two-day meeting of its policymaking committee, amounted to a lukewarm endorsement of the Trump administration’s top economic priority. Mr. Trump has suggested that the $1.5 trillion tax cut could nearly double economic growth to as much as 6 percent, a level far greater than most economists think likely.
The Fed continues to raise interest rates because officials are confident that the economy is in good health. This is the third time the Fed has raised its benchmark rate this year. “My colleagues and I are in line with the general expectation among most economists,” said Janet L. Yellen, the Fed’s chairwoman. She said they expected the bill to provide “a modest lift.”
In a statement published after a two-day meeting of its Federal Open Market Committee, the Fed said recent economic data showed that “the labor market has continued to gain strength and that economic activity has been rising at a solid rate.” Ms. Yellen spoke at a news conference after the Fed announced a widely expected decision to increase its benchmark interest rate by a quarter of a percentage point, to a range of 1.25 percent to 1.5 percent. The increase continues the Fed’s gradual march toward higher rates, which were cut to near-zero during the financial crisis. Wednesday’s increase is the third time this year that the Fed has raised rates, reflecting its confidence that the economy is in good health.
But the Fed remains cautious about the pace of rate increases. In an updated economic forecast, Fed officials predicted that inflation would stay below the Fed’s 2 percent target next year, and then stay at 2 percent in 2019 and 2020. With inflation expected to remain under control, Fed officials continued to predict a measured march toward higher rates. They forecast the Fed’s benchmark rate would rise to 3.1 percent by the end of 2020, up slightly from the last forecast of 2.9 percent. The Fed and Congress are moving in opposite directions. The Fed, in raising rates, is reducing the support it has provided to the economy since the financial crisis. Congressional Republicans, meanwhile, are preparing a $1.5 trillion tax cut for businesses and individuals with the aim of stimulating economic growth.
Concern about the low level of inflation led two officials to vote against the rate increase: Charles L. Evans, president of the Federal Reserve Bank of Chicago, and Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. In recent public remarks, both have said the Fed should wait to increase rates until there is clearer evidence that higher interest rates are needed to prevent inflation from rising too quickly. Some Fed officials, including Ms. Yellen, cautioned earlier this year that tax cuts could push the pace of growth to an unsustainable level, resulting in higher inflation, and that the Fed might respond by raising interest rates more quickly, to restrain growth and keep a lid on inflation.
With Wednesday’s rate increase a foregone conclusion — investors had put the chances at 100 percent — attention focused on what the Fed had to say about next year, particularly about the effect of the prospective tax cut. After seeing the details of the tax plan, however, Fed officials have concluded that there is no need to raise rates more quickly. A quarterly update of the Fed’s economic forecast showed that officials still expect to raise rates three times next year — unchanged from the last economic forecast.
“We continue to think that a gradual path of rate increases remains appropriate even with almost all participants factoring in their assessment of the tax policy, Ms. Yellen said. “We continue to think that a gradual path of rate increases remains appropriate even with almost all participants factoring in their assessment of the tax policy,” Ms. Yellen said on Wednesday.
Fed officials predicted that the tax cuts would deliver relatively modest economic benefits, adding a few tenths of a percentage point to the pace of growth. In part, the Fed has concluded the tax plan doesn’t pack a large punch. Fed officials predicted that the economy would grow at a 2.5 percent pace next year; the previous forecast was 2.1 percent.
Importantly, they also indicated that the economy had room to grow a little more quickly, and that they did not expect the stimulus to increase the pace of inflation. President Trump has predicted that the tax plan could deliver 4 percent growth or more.
Ian Shepherdson, chief economist, Pantheon Macroeconomics: Apprised of those comments by a reporter, Ms. Yellen responded: “I wouldn’t want to rule anything out. It is challenging, however, to achieve growth of the levels that you mentioned.”
The key result of the growth revision to next year is that unemployment is now expected to end the year at 3.9 percent, down from the previous 4.1 percent. This looks hopelessly unrealistic to us. The Fed appears to be assuming either a surge in productivity growth or a leap in participation; they might happen but we think a more likely end-2018 unemployment rate is 3.5 percent or less; had the Fed forecast that, they would have had to put in another rate hike in the dot-plot for next year. The inflation forecasts for 2018-20 are all unchanged from September, despite the tighter labor market. In short, the Fed forecasts an endless expansion, with minimal inflation pressure. The Fed also has learned that it’s not so easy to increase inflation, which has remained persistently low despite a tightening labor market and strengthening economy. The Fed aims to keep prices rising by 2 percent a year; it is on pace to undershoot that goal for the sixth straight year, and Fed officials on Wednesday predicted a seventh consecutive failure in 2018.
Luke Bartholomew, Aberdeen Standard Investments investment strategist: But the Fed’s outlook is also politically convenient, even if some analysts described it as overly optimistic. Republicans argue that the tax cuts will deliver a lasting boost to economic growth by encouraging investment. They do not want the Fed to get in the way by raising rates.
Today was never really about the hike — that’s been in the bag for a while — it’s about what the Fed does next. It’s clear that the Fed thinks it can hike three more times next year. But that’s a forecast that markets don’t yet buy, and it’s data more than rhetoric that will ultimately convince investors. Ian Shepherdson, chief economist at Pantheon Macroeconomics, described the Fed’s forecast as “hopelessly unrealistic.” He noted that the Fed was predicting that growth would be stronger than it expected, and unemployment would decline further, but without any increase in inflation.
Andrew Wilson, co-head of fixed income at Goldman Sachs Asset Management: “In short, the Fed forecasts an endless expansion, with minimal inflation pressure,” he said.
In 2018 we think that Powell will mirror Janet Yellen’s approach in 2017 and deliver three rate rises — more than the market is currently pricing in. Market expectations for United States monetary policy are in our view too dovish, creating room for a pickup in market volatility should the current Fed trajectory for rate hikes be recalibrated higher. Investors will be watching closely to see whether the Fed will be reactive to signs of higher inflation or pause to reassess its inflation outlook. It would be relatively easy for the Fed to respond if inflation does begin to climb. A thornier problem is the concern voiced by a minority of Fed officials that the central bank is already raising rates too quickly.
The Fed’s course will be charted under new leadership. Ms. Yellen is scheduled to preside at one more meeting of the monetary policy committee, in late January, before stepping down in early February — assuming that President Trump’s nominee to succeed her, Jerome Powell, is confirmed. Two Fed officials voted against Wednesday’s rate increase: Charles L. Evans, president of the Federal Reserve Bank of Chicago, and Neel Kashkari, president of the Federal Reserve Bank of Minneapolis. Mr. Evans has argued that the Fed may be holding down inflation by undermining public confidence that it will raise inflation back up to 2 percent.
Other senior officials also have recently departed or are planning to do so. The Fed’s rate increases have had little impact on financial markets, which have also shrugged off the Fed’s efforts to tighten borrowing conditions. Rates on many loans have declined since the Fed’s most recent rate increase, in June, and credit terms have loosened. Lee Ferridge, head of North American macro strategy for State Street Global Markets, said Wednesday’s decision was “a bit of a nonevent, quite honestly.”
Stanley Fischer resigned as the Fed’s vice chairman in October. William C. Dudley, the president of the Federal Reserve Bank of New York, has said he plans to step down in mid-2018. Asset prices, which have climbed strongly this year even as the Fed has raised rates, were largely unchanged on Wednesday. The Standard & Poor’s 500-stock index dropped 0.1 percent, closing at 2,662.85. The yield on the benchmark 10-year Treasury fell to 2.34 percent from 2.4 percent on Tuesday.
Replacements for Mr. Fischer and Mr. Dudley have not been announced, but Mr. Trump has already nominated a pair of new Fed governors: Randal K. Quarles, already installed as the vice chairman of supervision, and Marvin Goodfriend, who is awaiting Senate confirmation. Mr. Ferridge said the ongoing stimulus campaigns by other central banks, notably the European Central Bank and the Bank of Japan, were offsetting the effect of the Fed’s retreat.
And three more of the seven seats on the Fed’s board remain open and ready for Mr. Trump to fill. “You’ve still got huge amounts of liquidity coming into the system, and that’s what’s driving markets,” he said. “You’ve got the Fed tightening, but you’ve got global policy loosening.”
Some economists see the lack of tightening in financial markets as a reason for the Fed to raise rates more quickly, to prevent the formation of bubbles that could cause economic disruptions.
Ms. Yellen played down such concerns on Wednesday. She said the Fed saw little evidence that a fall in asset prices would cause broader pain. The use of borrowed money, for example, remains relatively modest by historical standards. “When we look at other indicators of financial stability risks, there’s nothing flashing red there or possibly even orange,” she said.
The Fed’s rate increases also haven’t had much impact on the domestic economy.
The average interest rate on a 30-year mortgage loan, at 3.94 percent last week, was lower than the 4.13 percent average rate at the same time last year, according to Freddie Mac.
But Ruben Gonzalez, an economist at Keller Williams, the real estate franchise based in Austin, Tex., said he expected mortgage rates to start rising gradually.
Mr. Gonzalez noted that housing prices were rising, and he said that higher mortgage rates could worsen affordability problems in some markets. “Any time rates are trending upward, and prices are growing at a rapid pace, affordability is going to be a big conversation,” he said.
The next round of monetary policy decisions will be made by a new group of leaders.
Ms. Yellen is scheduled to step down in early February, at the end of her four-year term. Mr. Trump has nominated Jerome H. Powell, a Fed governor, as the next chairman. He is awaiting Senate confirmation. Only one of the nine voting members of the monetary policy committee at the beginning of this year is expected to remain a voting member by the middle of 2018.
Ms. Yellen on Wednesday praised Mr. Powell as “somebody who understands the Federal Reserve very well and shares its values,” and she said she would work to ensure a smooth transition.
Asked about her own legacy, she described her time at the Fed as “immensely rewarding.”
“I feel good that the labor market is in a very much stronger place than it was eight years ago,” she said.