Stock Markets After Fed’s Dovish Rate Hike

Yesterday, the Federal Reserve Open Market Committee (FOMC) under the leadership of Jerome Powell concluded the final meeting of the year in which was dubbed as the most important day in markets. This is because the decision placed the Fed between a rock and a hard place. This is so because the Fed had initially guided for four rate hikes this year. In recent weeks, Donald Trump has continued to apply pressure on the Federal Reserve not to increase the borrowing costs. Therefore, the Fed had to balance between following through the previous guidance or leaving rates unchanged. Doing the latter would have exposed it to criticism that it caved in to pressure from the US president. This is important because the Fed is supposed to be independent.

To strike a balance between the Fed’s independence and the recent data, the Fed issued what was known as a dovish rate hike. In this, it increased rates but at the time lowered the expectations of the coming year. Instead of the three rate hikes, the Fed guided that it will hike two times. This was an expected move at a time when recent data has not been very supportive. The chart below shows the Fed’s dot plot.

(Click on image to enlarge)

In the statement, the Fed said:

The labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

The Fed also tweaked the language of the statement saying that the FOMC ‘judges that some further gradual increases will likely be needed.’ This was contrary to the previous statement that said that the FOMC ‘expects that further gradual increases will be needed.’

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