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Fed hits right notes as rates rise for the first time in nine years

The wishes of the majority of Europe’s fund selectors were fulfilled last night when Fed Chair Janet Yellen announced that the Federal Open Market Committee had decided to raise the fed funds rate by a quarter of a percentage point to between 0.25 and 0.5%.

Pointing out that the announcement brings to an end “an extraordinary seven-year period” in which the rate was held near zero to support the recovery of the economy from the worst financial crisis and recession since the Great Depression”, Yellen said it also reflected the FOMC’s confidence that the economy will continue to strengthen. 

But, she added, while the economic recovery has clearly come a long way, it is not yet complete. 

“Room for further improvement in the labor market remains, and inflation continues to run below our longer-run objective.”

As a result of this “the process of normalising interest rates is likely to proceed gradually, although future policy actions will obviously depend on how the economy evolves relative to our objectives of maximum employment and 2%,” she said.

Reiterating the point later in her prepared remarks, Yellen was clear to point out that the importance of this initial increase should “not be overstated”.

“Even after today’s increase, the stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2% inflation. As we indicated in our statement, the Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.

James Dowey, Chief Economist and CIO of Neptune Investment Management said the Fed did a good job of combining this first rate hike with “enough dovish messaging to take the sting out”.

On the dovish side, he elaborated, it highlighted the “gradual” path rates would take from here, but at the same time “it threw a bone to the hawks by sticking to its four hike-projection for 2016, as implied by the median projection of the FOMC members -four 25bp hikes taking the Fed funds rate to 1.375 by end 2016”.

However, Dowey said, Neptune maintains the market is only pricing in just over two hikes in 2016, as the consensus is currently putting a lot of weight on the possibility that the US economy will struggle with rising rates.

David Page, senior economist at AXA Investment Managers, took the implication of four rate hikes as a sign that it had failed to deliver a ‘dovish hike’ as these had been accompanied byno fundamental shift in its other economic projections to signify a more dovish outlook than in September”.

“We continue to expect a tightening in financial conditions to lead the Fed to deliver just three hikes next year. Yet financial markets took today’s move in its stride, with little today deviating from broad expectations.”

Salman Ahmed, global strategist at Lombard Odier Investment Managers, added: “Most importantly, she [Yellen]  managed to convince her diverse audience that policy will remain easy and any hiking from here on will be gradual and data dependent. With this key decision out of the way, we think the focus will turn on fundamental developments both in the US and internationally, which will shape both policy and market outcomes going forward.”

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Part of the Mark Allen Group.