It finally happened. The Fed raised interest rates a quarter of a percentage point for the first time in 2016, after forecasting four rate hikes a year ago. The decision was highly anticipated following the market’s surge post-Trump election (Paul Krugman’s biggest miss since the success of the internet).
Of course this still leaves interest rates down three quarters of a percentage point from last year’s projection, which may be why many aren’t buying the Fed’s forecast of three rate hikes in 2017.
As Bloomberg reports, the bond market sees the Fed overplaying its hand again:
Bond traders are signaling they agree with the Federal Reserve’s decision to project a steeper path of interest-rate increases. They’re just not sold on the frequency.
“If the Fed was only saying two rate hikes, the chances were the market would get there,” said Ward McCarthy, a senior economist at Jefferies. “Now three hikes increases the odds the Fed is overestimating again.”
Given the recent track record of the Fed, such skepticism is understandable. After all, the central bank’s record of misfires isn’t isolated to 2016.
As Jonathan Newman noted in October, the Fed’s forecasts have been comical:
While Bloomberg today gave kudos to the Fed’s models having better luck projecting inflation and unemployment, the Fed continues to whiff on GDP bigly:
Given its track record, it’s no wonder Fed Chair Janet Yellen had to admit to Congress earlier this year that she no longer sees “forward guidance,” a policy tool championed by her predecessor Ben Bernanke, as having much potency. Of course it is not simply the Fed dealing with a damaged reputation as public faith in all public institutions have been at historic lows since 2014.
Now that the Fed has made its last move of the Obama administration, it will be interesting to see the relationship between the central bank and the Trump administration.
Candidate Trump was a harsh critic of the Fed in general and Yellen in particular, accusing her of keeping interest rates low for political reasons. This has given some hope that Trump will end up cleaning house at the Fed.
Unfortunately, as was often the case on the campaign trail, Trump has been widely inconsistent on monetary policy — coming out as both an opponent and supporter of low interest rates. Steve Mnuchin, the former Goldman Sachs trader tapped to head the Treasury, praised Yellen during his post-nomination media blitz. Interestingly, when asked about her future during Wednesday’s press conference, Yellen indicated she may end up staying on the Fed’s board of governors — even if she is no longer serving as chair.
No matter what Yellen’s future holds, one of the great challenges that Trump and Mnuchin will face is likely to be the growing cost of financing the debt with interest rates creeping up. Trump has already announced ambitious plans including massive spending and tax cuts, which would only balloon upward if things go according to the Fed’s plan.
Of course, given its aforementioned track record, perhaps that’s a bet Trump is prepared to take.
