Treasurys Selloff as Fed Raises Rates, Adjusts Rate Hike Outlook

Fed Increases Rates as Expected, Boosts Future Rate Outlook More Than Expected  For only the second time in the last 10 years, and first time in 12 months, Federal Reserve officials raised the target range for the federal funds rate.  In-line with expectations and by unanimous decision, the Committee increased the benchmark borrowing rate by a quarter percent, elevating the range to 0.50% – 0.75%.  In its statement following the two-day meeting, the Committee cited “realized and expected labor market conditions and inflation” as the principal factors in support of the bump, noting that “job gains have been solid in recent months and the unemployment rate has declined.”  Perhaps the most notable takeaway from the meeting is the expectation for a faster pace of rate increases in 2017 and beyond.  Market forecasts in September had projected two rate hikes throughout the course of next year, however new projections reveal central bankers’ anticipate three quarter-point increases in 2017, along with three hikes in both 2018 and 2019.  Fed Chair Janet Yellen explained the “modest adjustment” in stating that inflation expectations have increased “considerably” and admitted that “some of the participants” have shifted assumptions based on the uncertainty of policies under a Trump administration.  “We are operating under a cloud of uncertainty … All the FOMC participants recognize that there is considerable uncertainty about how economic policy may change and what effect they may have on the economy, ” Yellen detailed.

The Federal Reserve’s full release can be found here.

In response to the boost in rate outlook, Treasury yields/swaps rates have gapped up 6-15 bps across the curve, bringing the yield on the 10-year Treasury to 2.58% – up 80 basis points in early November (pre-election) and up 120 basis points from the low 10-year yield recorded this past July.  All three major US stock indices closed down 0.15%-0.85% on the day, while the price of gold fell to a 10-month low.  The US dollar rallied about 1% against most major currencies, improving to its highest level in ten months against the Japanese yen.   

Economic Data Overshadowed on Fed Day
While not the highlight of the day, investors did receive a basket of other data that showed mixed results on the current condition of the US economy.  Both retail sales and industrial production data released were weaker than expected, while producer prices painted a brighter picture for demand.  Sales at US retailers reported a 0.1% rise (+0.3% expected) in November compared to the previous month’s downwardly-revised level of 0.6%, as consumers exhibited cautious spending during the month of the presidential election.  With household income rising and consumer sentiment reaching historic levels, November’s retail sales results have been labeled as a temporary weak point that should reverse in the coming months.  Other soft data included industrial production, which posted its largest drop over the last eight months at -0.4%.  November’s industrial production was largely weighed down by utilities output, which fell 4.4% for the month as unseasonably warm weather reduced demand for heating.  On the positive side, the producer-price index showed increases of 0.4% for the month, beating expectations of +0.1% and bringing the YoY gain to 1.3%.  The rise in producer prices signaled an uptick for inflation, as price pressures on the producer side may get pushed through to the consumer.