FOMC prepares for last meeting under Obama, markets prep for second rate hike in nearly 10 years

As the Federal Open Market Committee (FOMC) prepares to hold its final meeting under President Barack Obama, expectations are high that the Central Bank will raise rates for only the second time in the president’s eight-year tenure and send a jolt through U.S. and international markets.

Almost exactly a year ago, the FOMC decided on a small rate hike from 0.25% to 0.5%, ending almost seven years of a near-zero percent policy and raising federal funds rate for the first time in more than nine years.

Economist Ernie Goss, director of Creighton University’s Economic Forecasting Group and chair in Regional Economics in the Heider College of Business, said a rate hike is a foregone conclusion, but a shift toward more hikes under the new president will send shocks through the already tepid U.S. economy.

“Even though wholesale price inflation remains in a range indicating only modest upward price pressures, I expect the Federal Reserve to raise interest rates at the December meeting of the rate setting committee,” Goss said. “Markets will be paying close attention to remarks coming out of the Fed’s rate meeting … While a rate hike is expected, language indicating more rate hikes to follow will jolt markets.”

Jeremy Horpedahl, assistant professor of economics at the University of Central Arkansas, also expects to see a rate hike but said Arkansas’ economy is positioned to weather any short-term shock’s if monetary policy is shifted toward gradual rate hikes.

“The Fed will likely raise their target interest rate this week, but Arkansans should not be too worried about this change. The primary reason for raising rates is because the Fed views the economic recovery as going well, and they are worried about price inflation starting to creep up,” said Horpedahl, a scholar at UCA’s Arkansas Center for Research in Economics.

Horpedahl also reiterated that Arkansas has been one of the better performing states since the last recession, especially with historic low unemployment at 4.1%.

“States where recovery has been slow might be more worried about interest rate changes, but Arkansas is well positioned for policy to move to the next logical step of the recovery,” said the UCA economist.

ST. LOUIS FED CHIEF PREDICTS POLICY ‘REGIME CHANGE’
Meanwhile, FOMC member and the chief economist for the St. Louis Eighth District, which includes Arkansas and portions of Illinois, Indiana, Kentucky, Mississippi, the eastern half of Missouri and West Tennessee, is expressing view’s that the Central Bank is heading toward a new era going into today’s meeting.

In a presentation a week ago an annual economic forecast luncheon at Arizona State University, St. Louis Fed President James Bullard discussed whether the proposed policies of the incoming White House administration could impact current monetary policy.

“With inflation and unemployment close to longer-run levels, a standard recommendation is to set the policy rate equal to the real interest rate plus the inflation target,” Bullard said.

Under Bullard, the St. Louis Fed recently changed to a regime-based approach to near-term projections of the U.S. macroeconomy and monetary policy. Under this approach, the macroeconomy delivers a very simple forecast of U.S. macroeconomic outcomes over the next 2-1/2 years, meaning only one interest rate increase is necessary during that period.

Over this horizon, the forecast is for real output growth of 2%, an unemployment rate of 4.7%, and trimmed-mean inflation of 2%. Bullard last week described two real interest rate regimes, noting that a high-real-interest-rate regime prevailed in the 1980s and 1990s, but a low-real-interest-rate regime now prevails. He explained that the real returns on safe, short-term assets, such as short-term government debt, are exceptionally low and are unlikely to return to their historical levels over the next two to three years.

“Because we are in the low-real-rate regime, the St. Louis Fed’s policy rate recommendation comes out to a low number,” said Bullard, noting that the policy rate setting is 38 basis points, or 0.38%. “I conclude that a single 25-basis-point increase in the policy rate – from 38 to 63 basis points – will get us very close to the standard recommended value over the forecast horizon.”

Bullard and other members of the FOMC will conclude their two-day meeting Thursday (Dec. 14) at 1 p.m., at which time the committee will issue its economic projections for 2017. Immediately afterward, Fed Chair Janet Yellen will hold a press conference to discuss any market concerns and President-elect Donald Trump’s efforts to reshape the economy.

The first FOMC meeting under of the Trump administration will be held Jan. 31, 11 days after the Republican businessman turned politician takes office.