The Federal Reserve (Fed) waved farewell to Janet Yellen this week, as she participated in her final Federal Open Market Committee (FOMC) meeting as Chair of the U.S. Central Bank. The meeting itself appeared fairly uneventful, with Yellen providing no surprises as she headed for the exit after her four year term.
As expected, the federal funds rate range was left unchanged at 1.25% to 1.50%, while only very modest changes were made to the post-meeting statement from December last year. Arguably the most interesting update was contained within the forward guidance: prior references to the expectation for “gradual adjustments” in monetary policy and “gradual increases” in the federal funds rate are both now preceded by the word “further”. This subtle edit was taken to signal a departure from restraining market expectations for multiple rate hikes, to reinforcing the anticipation of multiple increases. In view of this, the first of these arriving at the 21 March FOMC meeting is probably the most consensus view in markets at present. The market implied probability of a 0.25% hike now stands at 99%, having risen seven percentage points since the beginning of the week.
Yellen hands the reins to Jerome Powell, who will be sworn in as the new Fed Chair on Monday at an interesting time. While Yellen successfully delivered on one of the FOMC’s mandates during her tenure, namely maximum employment, the second objective of 2% inflation has persistently been undershot. The Committee’s current view is that with monetary policy remaining accommodative, the labour market will continue to strengthen and inflation will stabilise around the target level on a 12 month basis. In conjunction with fiscal stimulus from the Trump administration, the market continues to believe that the Fed will have scope to make multiple hikes in 2018 as they pursue this inflation goal.
From a wider perspective, however, whether inflation will even remain as great a focus for setting U.S. interest rate policy going forward remains to be seen. There has been some discussion in the market suggesting that the Fed may look to target a range of inflation going forward, rather than a firm single point. Clearly this would afford the Fed increased flexibility. However, it would also create less certainty for markets, and imply increased volatility across asset classes and indeed the U.S. Dollar. How this situation develops is something to be monitored closely as Powell sets out his stall for the next four years.