Eaton Vance
December 15, 2016
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Fed reaction: The hawk attack is back

Eric Stein,

Co-Director of Global Income

Boston - While the widely expected 25 basis point rate hike was a complete non-event from a market perspective, there was a big surprise in Wednesday's FOMC statement. The median dot in the Federal Reserve's "dot plot" now indicates that there will be three rate hikes in 2017, up from two in the last version.

In the statement, the Fed noted that the labor market "has continued to strengthen" while job gains "have been solid in recent months." This indicates that officials are confident with the ongoing improvement in the labor market. The Fed made some minor tweaks to its 2017 GDP forecast (2.1% vs. 2.0%), while revising down its unemployment rate from 4.6% to 4.5%.

However, those updates are very small in comparison to changes that may actually occur in 2017 if the Trump administration and Congress are able to enact significant tax and regulatory changes, as well as increase infrastructure spending. The immediate market reaction to the statement and dot plot was a big bear steepening of the U.S. rates curve, with the front end selling off significantly and a strengthening of the U.S. dollar.

Bottom line: This was an unexpected hawkish dot-plot from the Fed. For a long time, central bankers have been practically begging fiscal policymakers to act so monetary policymakers don't need to be the only game in town. We haven't seen any fiscal action yet, but if the labor market continues to strengthen and inflation eventually rises above the Fed's 2% target, expect more hawkish surprises from the FOMC in 2017.

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