Markets Digest Effects of Fed Liftoff

Stocks reversed some of yesterday’s gains while Treasuries have rallied 1-5 bps across the curve, as markets digested the first FOMC rate hike in almost 10 years.  Yesterday afternoon the FOMC unanimously voted to raise the federal funds target rate by 25 bps to 0.25% – 0.50%, signaling the US economy is on solid enough footing to begin moving away from unprecedented monetary stimulus.  As expected, the Fed emphasized that subsequent hikes will be “gradual” and will depend on incoming data and how the Fed’s forecast evolves.  The Fed’s policy statement cited “considerable improvement” in the US labor market, and said committee members are “reasonably confident” inflation will approach the Fed’s 2% target in the medium term.  The updated economic projections were largely unchanged from September, with the unemployment rate expected to decline to 4.7% and GDP hitting around 2.4% in 2016.  The Fed’s dot plot signaled policymakers project four interest rate hikes in 2016, which would bring the benchmark rate up to a median of 1.4%.  The Fed’s long run expectation of 3.5% for short rates remained unchanged from recent projections.  

Money market rates continue to respond to the Fed action with the Prime rate set by most banks up 25 bps to 3.50%, while LIBOR across the curve moved up again today to fresh highs since 2009. Now that the Fed has given clear direction on its intention for a gradual tightening cycle, investors can focus on US fundamentals.  Economic data released today showed jobless claims fell to 271,000 last week, below both the 275,000 estimated, and the 282,000 in the week prior.  This marks the 41st consecutive week that claims remained below 300,000, reaffirming the labor market strength.  The US claims data have not experienced a run that long since the early 1970s.  Claims tend to be volatile around the holiday season, but the Labor Department declared that there has not been any special market factors influencing current data.  A separate Commerce Department report showed a large increase in the current account deficit.  The 11.7% increase to $124.1 billion is the largest shortfall since the fourth quarter of 2008.  With the Fed’s policy divergence from other central banks, a strengthening dollar is likely to continue to weigh on exports.

There are no scheduled Fed speakers today, but there is supply in the form of the $16 billion 5-year TIPS auction.