Next Fed rate hike likely in Q1

Bank underscores gradual tightening

Wall Street’s top banks expect the Federal Reserve to next raise US interest rates in the first quarter of next year, according to a Reuters poll conducted on Wednesday, after the Fed raised rates for the first time in more than nine years.

A total of 13 of 21 primary dealers, brokerages that deal directly with the Federal Reserve, say the Fed will next raise rates in the first quarter, after it raised the range of its benchmark interest rate by a quarter of a percentage point to between 0.25 and 0.50%.

The remaining eight dealers say the Fed will raise rates by the second quarter.

It was the first rate increase by the Fed since 2006.

The Fed’s projections, released with its statement, show it still anticipates a federal funds rate of 1.4% by the end of 2016, which implies four interest rate increases in 2016, or one per quarter.

When Reuters last polled primary dealers, the median forecast was for a fed funds rate of 1.125% at the end of that year.

Some had expected the Fed to scale back its forecast for the pace of its interestrate hikes, but the Fed’s expected path still implies a more gradual tightening cycle than previous efforts.

In its statement, the Fed made clear that the rate hike was a tentative beginning to a “gradual” tightening cycle, and that in deciding its next move it would put a premium on monitoring inflation, which remains mired below target.

“In light of the current shortfall of inflation from 2%, the committee will carefully monitor actual and expected progress toward its inflation goal. The committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate,” it said.

The Fed’s rate hike was the first in nearly a decade, and the first move in policy since it lowered rates to the zero-bound range during the financial crisis.

New economic projections from Fed policymakers were largely unchanged from September, with unemployment anticipated to fall to 4.7% next year from the current 5% and economic growth at 2.4%.

Still, the outlook for inflation is low. In its most recent projections, the Fed lowered its expectation for 2016 core inflation growth to 1.6%, down from its previous 1.7% expectation.

“As anticipated, the FOMC adjusted its language on i nflation, putting actual outcomes on the same level as expected progress.

“This would slow the pace of rate hikes if inflation keeps surprising to the downside. But the opposite is also true; faster inflation might warrant a faster pace of hikes,” wrote economists at Credit Suisse, after the meeting.

The Fed is expected to maintain the fed funds rate through a number of tools, most importantly the interest rate on excess reserves, or IOER, the payment to banks for the $2.5 trillion or so reserves they currently hold at the Fed. That rate represents the upper end of the fed funds range, at 0.5%.

The Fed will also use the overnight reverse repurchase programme to drain reserves. That RRP rate represents the floor of the range; it was raised to 0.25%.

Since the beginning of the Fed’s efforts to provide extraordinary monetary stimulus, the central bank has ballooned its balance sheet to approximately $4.5 trillion in various types of securities, from about $870 billion in mid-2007.