The Federal Reserve on Wednesday lifted U.S. interest rates as expected, enthusiastic about the road ahead, saying the economic outlook had strengthened in recent months.
As expected, the Fed raised its benchmark federal-funds rate by a quarter percentage point to a still-low range of 1.5 percent to 1.75 percent. It was the sixth quarter-point move since December 2015. People were not surprised as Fed Chairman Jerome Powell had delivered a statement to Congress that implied the probability for a March rate hike.
Simeon Hyman, Head of Investment Strategy at ProShares, told ETF Trends that Powell expressed a slightly more hawkish policy stance today with perhaps one extra hike over the next couple of years, and an indication that inflation might make it just past the Fed’s 2% target to 2.1% next year.
“Investors might be wise to focus more carefully on a potentially bigger driver of interest rates – changes in real yields,” Hyman told ETF Trends. “The long term average real return on a US ten year treasury bond runs around 2.5%. Today, it’s around 1%. The closing of that 1.5% gap could move yields a lot more than inflation rising from 1.7% today to the Fed’s target of 2%, or to their current forecast of 2.1%.”
Hyman said one of the key drivers of closing that real yield gap was the unwinding of the balance sheet.
“Chairman Powell’s reiterating of the Fed’s accelerating pace of this unwind is a reminder that real yields are likely to normalize, and yields of 4% or higher on the US ten year treasury might not be so far away,” Hyman said.
Rising Interest Rates
However, according to the Wall Street Journal, “officials think they will need to raise interest rates at least four times this year if the economy performs in line with their expectations. Some seven of 15 participants now expect at least four rate increases this year, an increase from four of 16 participants at the December meeting.”
The vote to raise interest rates at the meeting was unanimous with all eight in favor of the rate increase. Because the economy is growing significantly faster than expected, officials see rising pressure on resources which could mean more changes to come.
What to Expect
According to the Washington Post, “Americans should expect even faster growth and lower unemployment ahead, Fed officials said. Unemployment is now expected to fall to 3.8 percent this year and 3.6 percent in 2019, which would be the lowest level in decades.
Kevin Flanagan, a senior fixed income strategist at WisdomTree noted, “While the Fed did not officially change its number of 2018 rate hike projections at this meeting, the issue probably will be revisited, data permitting. Keep in mind that the Fed did tighten four times last year: three rate hikes and a balance sheet normalization announcement at the September FOMC meeting.”
The big question now is how much Fed officials expect to lift rates in the coming years.