Fed Raises Rates, Maintains Forecast for One More Hike

• Central bank maintained outlook for one more increase in 2017
• Policy makers set out details for shrinking the balance sheet 

The Federal Reserve approved its second rate hike of 2017 even amid expectations that inflation is running well below the central bank's target.

In addition, the Fed provided more detail on how it will unwind its $4.5 trillion Balance Sheet, or portfolio of bonds that includes Treasurys, mortgage-backed securities and government agency debt.

US Federal Reserve minutes (FOMC):

As financial markets had anticipated, the policymaking Federal Open Market Committee increased its benchmark target a quarter point. The new range will be 1 percent to 1.25 percent for a rate that currently is 0.91 percent.  The level impacts most adjustable-rate and revolving debt like credit cards and home equity loans. The prime rate that banks use as a baseline for interest rates usually rises immediately after the Fed makes a move.

Policy makers agreed to raise their benchmark lending rate for the third time in six months, maintained their outlook for one more hike in 2017 and set out some details for how they intend to shrink their $4.5 trillion balance sheet this year. In a press conference after the decision was announced, Fed Chair Janet Yellen said the unwinding plan could be put into effect “relatively soon” if the economy evolves as the central bank expects.

Near-term risks to the economic outlook appear roughly balanced, but the committee is monitoring inflation developments closely,” the Federal Open Market Committee said in a statement Wednesday following a two-day meeting in Washington. “The committee currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated.

The Fed’s actions and words struck a careful balance between showing resolve to continue tightening in response to falling unemployment while acknowledging the persistence of unexpectedly low inflation this year.

Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the committee’s 2 percent objective over the medium term.

Economic Data

Data released earlier Wednesday showed that, on a year-over-year basis, the core version of consumer price inflation, which strips out food and energy components, slowed for the fourth straight month, to 1.7 percent in May. Following that news, the probability that the June hike would be followed by another increase this year dropped to about 28 percent from 48 percent, according to pricing in fed funds futures contracts.

In a separate statement on Wednesday, the Fed spelled out the details of its plan to allow the balance sheet to shrink by gradually rolling off a fixed amount of assets on a monthly basis. The initial cap will be set at $10 billion a month: $6 billion from Treasuries and $4 billion from mortgage-backed securities.

The FOMC retained language that it expects to keep raising interest rates at a “gradual” pace if economic data play out in line with forecasts.

Yellen Remarks

Wednesday’s decision brings the Fed’s target for the federal funds rate, which covers overnight loans between banks, to a range of 1 percent to 1.25 percent.

The vote was 8-1, with Minneapolis Fed President Neel Kashkari dissenting from a rate increase for the second time this year, preferring no change.

Quarterly projections for 2018 and 2019 showed Fed policy makers largely maintained their expected path for borrowing costs. The median forecast still has the central bank making three quarter-point increases in 2018; the end-2019 rate is seen at 2.9 percent, a slight change from 3 percent in the March projections.

The Fed has in recent weeks wrestled with contradictory signals from unemployment and inflation. Joblessness in the U.S. dropped to a 16-year low at 4.3 percent in May. Despite that, the Fed’s favorite measure of price pressures, excluding food and energy components, rose just 1.5 percent in the 12 months through April, down from 1.8 percent in February. The Fed’s target for inflation is 2 percent.