Most likely by now, you’ve heard that the Federal Reserve raised interest rates this week by 25bps to the range of 1.25 to 1.50%. This is the third interest rate increase of 2017 in their final meeting of the year. This will also raise the PRIME index rate to 4.5% which most home equity loans are tied to.
One of the interesting results of the Fed decision this week was that there were two dissents; that is two FOMC members voted against the interest rate increase. Both Charles Evans and Neel Kashkari have been rather vocal recently that the Fed should wait longer to raise rates until there is clearer evidence of inflation.
The Fed’s forecast suggests they plan to raise rates three times in 2018 even though their inflation forecast remains below 2%. This contradiction means there will be controversy next year if the Fed continues to raise rates when the economy is still showing no signs of accelerating inflation.
In terms of inflation take a look at the graph on your screen which shows the two most popular measures of inflation, CPI and the Fed’s preferred measurement, PCE. As you can see they both are running well below the 2% line in red and have moved lower over the past year.
Further evidence of the Fed’s controversial interest rate increases is the yield curve. It’s important to note that even though the Fed has raised short-term rates 100bps in the past 12 months, the 10yr Treasury is actually down 10bps over the same time period and the spread between the 2yr and 10yr Treasury is down 65bps. This tells us that the market is not concerned about inflation, nor rapid growth and more likely than not the Fed is raising rates to position themselves in case of a future recession.
In the coming weeks you should keep an eye on the following items:
- Tax reform is still the top thing to keep an eye on with both the House and Senate working on a combined bill.
- The shape of the yield which is the difference between short term and long term rates. The Fed is raising short-term rates but will long-term rates follow?
- And lastly, did I mention the tax bill. This could have huge implications for businesses, individuals and the economy. How will it impact interest rates?