It was pretty well telegraphed. This week the Federal Reserve raised the target rate range to 2.0-2.25% in a move that was widely expected. While we often look to the futures market to calculate implied probabilities of an action (the rate increase was 98% priced in just before the announcement), the effectiveness of Fed communication can be best evaluated by the broader financial market reaction after the news hits the tape. By that measure, they did a pretty good job of setting market expectations correctly. The yield on 10-year US Treasury bonds, which had risen above 3.1% just the day before, fell a few basis points on the day to end just a few “bps” above 3%. The US equity market was relatively resilient, but ended the day down a bit just before the close. It would be easy to say that the release of the written Fed decision (which is parsed for any changes in language) that removed the reference to “accommodative” policy in the future might have caused a stir, but in the grand scheme it was a quiet day in the market.
As we have discussed in the past, one of the biggest risks to economic growth and the equity market rally is a monetary policy mistake and for now that seems to be held at bay. Markets have absorbed these increases at each step with little to no disruption. Jokingly, the communication has been so clear that if the Fed was a publicly traded stock perhaps it would be classified under the new Communication Services sector (which launches tonight)! At this point, while the 10-year yield is now up at the 3% mark, it has been attended by a rise in the “real” interest rate (proxied by the yield offered by the Treasury Inflation Protected security or TIP) and so implied inflation expectations remain at roughly 2%. While we would not take that as a true forecast of future realized inflation, it is an indication that the market believes the Fed is running on a path that is neither too fast nor too slow.
That said, we will stay vigilant. Without a further rise in long-term yields, we may face a perfectly flat yield curve come the next meeting in December (with the probability leaning towards hike) which, while clearly different than an inverted curve, is not the kind of news you want to have come over the wire.