Does the Fed's Rate Hike Indicate a Stronger Economy?

Higher interest rates tend to boost the dollar, but as the tightening had been well telegraphed by Fed Chairwoman Janet Yellen, the rate hike had been nearly 100% priced in, analysts said. But the number of Fed officials who think three rate hikes will be appropriate rose from six to nine.

Investors lodged large bets on the dollar after Donald Trump's US presidential election win a year ago, expecting his mix of tax reform, capital repatriation and new public spending to raise inflation in the United States and in turn drive Fed rates higher. Those forecasts are far below the 4 percent growth that President Donald Trump has said he can produce with his economic program.

"Yesterday's hike can be described as a "dovish hike" or "neutral" at best".

"They don't want to prematurely set the table for a rate hike", Vitner said. "We have some confidence in the path the economy is on".

The greenback had struggled to make good on that promise until the past fortnight, when a combination of upbeat data and the continued positive momentum of the stock market underwrote a change in Fed policymakers' rhetoric.

"In view of realized and expected labor market conditions and inflation,"the Fed made a decision to raise the target range for the federal funds rate by 25 basis points to a range of 0.75 to 1.0 percent, the Fed's policy-making committee said in a statement released after its two-day meeting".

The U.S. Federal Reserve has resumed normal monetary service by raising interest rates for the second time in three months. But it did note that inflation, after lagging at worrisomely low levels for years, has picked up and was moving near the Fed's 2 percent target. The jobless rate is 4.7 percent, at or near a level consistent with full employment.

That the Fed is no longer unsettling investors with the signal of forthcoming rate increases marks a sharp change from the anxiety that prevailed after 2008, when the central bank cut its key rate to a record low and kept it there for seven years. Therefore, he expected the Fed to have three rate hikes this year and four in 2018. Keeping rates too low limits the Fed's monetary policy options when responding to economic turmoil.

But now, the economy is widely considered sturdy enough to handle modestly higher loan rates. The 5-year forward inflation expectation rate, a market gauge tracked by the Fed, now stands at 2.14 per cent, up from 1.60 per cent one year ago.

The rate increase came amid a broad improvement in the world economic outlook and a sense among Fed policymakers that the US economy is close to the central bank's employment and inflation goals. While acknowledging that it is still too early to anticipate exactly how the Trump administration's fiscal policies may unfold, the central bank is intimating that it will be closely monitoring the new dispensation's broad budget plans and remains ready to change policy tack if it were to perceive any risks to its price stability goals.

Yet for the same reason, some caution that if Trump's program fails to survive Congress intact, concerns will arise that the president's plans won't deliver much economic punch.

Labor groups have urged the Fed to raise rates as slowly as possible so hiring can continue and wage increases take hold. Already, the current expansion, which officially began in 2009, is the third-longest in the post-World War II period.

  • Todd Kelly