Federal Reserve Chair Janet Yellen testifying during a Congressional Joint Economic Committee hearing in December. (Nicholas Kamm/AFP/Getty Images)
The wait is over. The Federal Reserve announced Wednesday that it is increasing the target for short term interest rates to a range of 0.25% to 0.50% from a range of 0% to 0.25%. The move, while small, is historically significant. The Fed has held interest rates near zero for seven years and has not raised them since 2006.
In a statement released following a two day meeting of the Federal Open Market Committee, the central bank’s team of policy makers judged the United States economy is expanding at a “moderate pace.” The labor market, they said, has shown ”considerable improvement.” While inflation is below the committee’s 2% target, they remain convinced it will get there in the “medium term.”
The release was carefully worded to show that the FOMC will not be on autopilot going forward. At each of the committee’s eight annual meetings the economists will decide whether or not to add to the short term target. At least through 2016 this is unlikely to mean a hike at every meeting or even every other meeting. This is in contrast to the last period of rising rates when the Fed hiked at each meeting from May 2004 to June 2006 — 18 times in all.
On the pace of rate hikes the statement says: “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”
While Wednesday’s hike is the first raise in years, the Fed has tightened monetary policy in other ways, like letting its monthly asset purchase program lapse in late 2014 following a months-long reduction in the size of purchases. In other words, the long-awaited rate increase is just the most recent in a string of gradual steps away from crisis era policy, albeit modest ones. In the Fed’s own view, “The stance of monetary policy remains accommodative after this increase, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.”
Before Wednesday observers were generally interpreting “gradual” as between two and four increases in 2016. Gus Faucher, senior economist at bank PNC, for example, imagined a scenario where the Fed moves at alternating meetings for the first half of the year — perhaps March and June — and then takes a breather around the fall. This would allow them to assess the situation, while also keeping the committee from appearing too political ahead of the November 2016 presidential election.
The path of the Federal Funds Rate from 2000 to December 2015.
Others say rate advance will continue as long sailing is smooth. Jeremy Lawson, chief economist at asset manager Standard Life Investments, pointed out in an interview Tuesday that after seven years of near zero rates no one can be sure how the economy and financial markets, so changed by the financial crisis, will absorb real rates. Investors will surely be listening for more clarity on the expected path of rates during Chair Janet Yellen’s press conference at 2:30 p.m. Wednesday.
As long as the pace remains unfixed, however, questioning it will likely be sport on Wall Street, replacing the well-worn discussion of when the Fed would first act, though perhaps less energetically. The will-they or won’t-they debate had become a nearly monthly ritual on Wall Street in 2015. In contrast to the periods leading up to prior meetings, however, Yellen and other FOMC members have pushed hard in recent weeks to make it clear that barring major economic shock they would move in December, at their final meeting of 2015.
Recent data releases have supported the Fed’s desire to act, even if they have not been strong enough to inspire great optimism among average Americans. A clear turning point came on the first Friday of December when the Bureau of Labor Statistics said employers added 211,000 jobs in November and that the unemployment rate held steady from the previous month at 5%. The report included an upward revision to an already-strong October jobs figure, to 298,000.
Markets climbed on the news. Immediately following the release the Dow Jones Industrial Average, Nasdaq Composite and S&P 500 Index were each up close to a percent before settling between 0.4% and 0.6% as the press conference approached.
Meanwhile the yield on the 10-year Treasury note was at 2.29%, after spending the earlier part of the day between 2.28% and 2.32%. According to the Chicago Mercantile Exchange, 7% of futures investors now anticipate a January rate hike and 47% expect a hike in March.
The rate hike caused oil and gold to fall. The dollar index initially spiked but the gains petered out as traders read the commentary. West Texas Intermediate traded below $36 a barrel in the minutes after the Fed’s announcement, down from $36.18 ahead of the release. The dollar index shot up to session highs of $98.48, while gold fell below $1,700 a troy ounce.