Four key points from the Fed’s meeting - Financial Times

Federal Reserve
Four key points from the Fed’s meeting
Policymakers’ ‘dot plot’ for 2017 overshadows expected decision to raise rates

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4 HOURS AGO by: Eric Platt and Joe Rennison in New York
US government bond markets were jolted by the Federal Reserve’s unexpectedly hawkish turn on Wednesday, when the US central bank increased interest rates for the second time since the financial crisis and set a more aggressive path for tightening than investors had anticipated.
A sell-off accelerated into the close of trading, with the yield on the two-year note climbing 10 basis points to 1.263 per cent, the highest level since August 2009 shortly after the US emerged from recession. Yields rise as bond prices fall.
Losses were concentrated in the shortest-dated US Treasuries, with the three- and five-year Treasury yields rising 11 and 13 basis points, respectively. The dollar clinched its best daily performance in a month, rising 0.9 per cent against a basket of currencies, while commodities including oil and gold sank.
Stock markets weakened, led by declining shares of energy, utility and real estate companies, the latter two highly sensitive to changes in monetary policy expectations. The S&P 500 dipped 0.8 per cent and the Dow Jones Industrial Average, which at one point in the day was 34 points from eclipsing the 20,000 level, fell 0.6 per cent.
Several investors said they had expected a more dovish announcement, given the uncertainty of President-elect Donald Trump’splans to boost government spending and cut taxes that the incoming administration hopes will accelerate economic activity. But momentum in the US economy that began before the election won a vote of confidence from policymakers, with Fed chair Janet Yellen saying she expects progress to continue.
“The surprise and what the market is reacting to is that most people expected a wait-and-see stance from the [Fed] in terms of how they would consider the impact of Trump-enomics in the year ahead,” said Ian Lyngen, a strategist with BMO Capital Markets. “It was a bit of a surprise seeing the Fed buy into the market’s optimism.”
Four key points from the meeting . . .
Three not two
The widely anticipated decision to raise interest rates was overshadowed by the Fed’s policy projections. Along with its decision to lift the target range of federal funds futures to between 0.5 and 0.75 per cent, policymakers at the US central bank plotted a more aggressive path for 2017. The so-called dot plot — the individual projections of officials on the Federal Open Market Committee — showed policymakers projecting three quarter-point rate rises in 2017, up from the committee’s forecast for two when it met in September.
It is a signal from the Fed of confidence in the strength of the US economy, with firming inflation expectations and a healthy labour market, Ms Yellen said.
“We have opened the door” to a faster tightening cycle, said Scott Minerd, chief investment officer of Guggenheim Investments. “If the data continue to come in how we expect, the Fed will have to move faster than people were expecting.”
Beyond 2017, the Fed policymakers projected two increases a year through 2019 and lifted their long-term view of where rates will find equilibrium.
It is a signal from the Fed of confidence in the strength of the US economy, with firming inflation expectations and a healthy labour market, Ms Yellen said.
“We have opened the door” to a faster tightening cycle, said Scott Minerd, chief investment officer of Guggenheim Investments. “If the data continue to come in how we expect, the Fed will have to move faster than people were expecting.”
Beyond 2017, the Fed policymakers projected two increases a year through 2019 and lifted their long-term view of where rates will find equilibrium.

Fixed income pummeled
The sell-off was swift in government bond markets, with knock-on effects felt in investment-grade corporate bonds and emerging market debt.
Yields across the Treasury curve climbed as investors cut positions in US government debt, but this was concentrated on shorter-dated notes. The yield on the 10-year Treasury closed above 2.5 per cent for the first time since September 2014 while the five-year note passed 2 per cent for the first time since May 2011.
“We’re on our way to a 2.75 per cent [yielding] 10-year,” said Rick Rieder, BlackRock’s chief investment officer of fixed income. “I don’t subscribe to the thesis we’re moving to much higher interest rates, but it will be pretty hard until we get other information from the Fed for interest rates to do anything other than drift higher.”
US paper has suffered as investors prepare for faster economic growth and a more aggressive Fed, as well as with the concern that deficits could be funded with a spurt of new Treasury issuance. The yield curve flattened materially, with the difference between five and 30-year paper declining 9 basis points to 113bp, the lowest since September.
The weakness spread to Asian sovereign bond markets as they opened, with yields on 10-year Japanese, Australian and New Zealand government debt rising.

The boon to the dollar
The surge in yields have bolstered the greenback’s appeal, with the DXY dollar index hitting its highest level since 2003 on Wednesday.
The gain has been propelled by the accelerating divergence between US and global rates, with the attraction of higher yields on US sovereign bonds drawing investors to the country’s currency.
The difference between the yield on two-year Treasuries and the safe-haven two-year German Bund hit a high of 205 basis points on Wednesday, a level last touched in 2000. The premium to Japanese two-year notes surged to nearly 150bp, the highest since 2008.
The yen subsequently fell to a 10-month low while the euro slipped below $1.05. As central banks in Europe and Japan retool policy to jumpstart economic activity and inflation, they remain at stark odds with the Fed as the latter tightens policy.
“The US dollar may have been ahead of the Fed in digesting what the US election result might mean for growth, but it will still likely strengthen further on the Fed’s swifter than expected conversion to a possible fiscal reflation theme,” said Daragh Maher, a currency strategist with HSBC.

The market is now (mostly) in agreement with the Fed
The Fed has repeatedly overestimated how quickly it would raise interest rates, drawing the ire of investors and traders who last December put the odds on four quarter-point hikes — as the central bank then projected — at roughly 9 per cent.
On Wednesday traders put the odds on three 25bp rises in 2017 at roughly 45 per cent. Two or more? Traders put those odds at more than 76 per cent, according to calculations on federal funds futures by Bloomberg.
The alignment is visible in December fed funds futures contracts, which climbed to 1.165 per cent on Wednesday. The median of the Fed’s projection: 1.375 per cent.
“The Fed won’t feel constrained because the market isn’t pricing in the level of tightening that they wanted to deliver, which is what we saw in 2016,” Mr Lyngen added.

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