Wednesday, March 15, 2017

Why the Markets Responded As They Did To The Fed's Rate Hike

From Quartz:

The Fed’s rate hike went off without a hitch—until investors read the fine print
For a minute, everything went according to plan. 

The US Federal Reserve raised its benchmark interest rate by 0.25 percentage points today, as expected. The key rate that banks offer to lend to each other overnight—which underpins the entire American financial system—will now be set between 0.75% and 1%, up from a 0.5% to 0.75% range.

After going a year without touching rates, this is the second hike in only three months. Fed officials made no secret of their intentions this month, with markets gearing up for a more rapid return to “normal” rates after a long period of hovering just above zero. 

But buried in the details of the Fed decision was something that investors weren’t betting on. Markets lurched—stocks up, bond yields and the dollar down—as soon as people realized that Fed chair Janet Yellen and her colleagues didn’t come off nearly as hawkish as expected. 

The Fed’s latest economic projections (pdf) suggest that officials don’t think the economy has switched into a higher gear. The forecasts imply only three interest rate hikes this year (including today’s), which is the same as expected in December. The median long-run annual GDP growth projection is just 1.8%, again the same as it was three months ago. In both cases, analysts thought that more rate hikes and stronger growth would be on the menu.

Look at what happened to the 10-year yield on US Treasuries, and you can see how traders were caught off-guard. The dollar also took a tumble, falling 1.2% against the Japanese yen at the time of writing.

Last year, the Fed also erred on the dovish side. They started 2016 predicting four rate hikes in the year, but instead squeezed in just one quarter-point increase at the very last meeting of the year....