At its last policymaking meeting for the year, the Federal Reserve raised interest rates on Dec. 14 for the first time in 12 months and, to the surprise of the market, indicated it could raise rates three more times in 2017, not the two times the market had expected.
The FOMC increased its short-term federal funds rate by 25 basis points to a range of 0.50% to 0.75% "in view of realized and expected labor-market conditions and inflation," according to the Fed's statement. More importantly, it raised its fed funds rate projections to a median 1.4% in 2017, up from 1.1%, indicating a third rate rise next year instead of the two that it had projected at its September meeting.
When asked in her press conference following the decision why Fed policymakers raised its expectations for rate hikes from two to three next year, Fed Chair Janet Yellen noted the change was due to a few factors: a lower projected unemployment rate – now 4.5% instead of 4.6% – and a "slight upward revision to inflation."
She said the change was a "very modest adjustment" that involved changes by only some Fed participants, indicating that this was not "a wholesale change" in outlook, said Karissa McDonough, fixed income strategist at People's United Wealth Management.
Market reaction to the Fed decision was mixed. The Dow Jones industrial average initially rose modestly then reversed, falling more than 100 points to near 19,800 by 3:30 p.m., and the 10-year Treasury yield rose to 2.53%.
The biggest move was in the U.S. dollar. The U.S. dollar index soared to 101.76, from 101 at the previous close.
McDonough as well as Jack McIntyre, portfolio manager at Brandywine Global, and Roger Aliaga-Diaz, Vanguard chief economist for the Americas, all commented that the Fed's projection for three rate hikes next year signal that the central bank is intent on controlling inflation longer term and not falling behind the yield curve as some analysts have been saying.
