The Fed raises interest rates again, saying 'economy is doing well'

WASHINGTON-- Don’t look now, but nearly eight years after the Great Recession ended, it’s finally starting to feel like a normal economy again, at least judging by the Federal Reserve’s second interest rate hike in three months

The Fed on Wednesday raised its benchmark short-term rate by a quarter percentage point to a range of 0.75% to 1% and stuck to its forecast of two more such increases this year and three in 2018. Some economists had expected Fed policymakers to modestly step up the pace.

Wall Street cheered the Fed’s decision but reacted with restraint. The Dow Jones industrial average rose 113 points, or 0.5%, to 20,950. “The market got everything it wanted,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott. The Fed “signaled the economy is doing better but reaffirmed that the pace of (rate hikes) will be gradual.”

The move is expected to filter through the economy, pushing up rates slightly for everything from mortgages and car loans to credit card debt and bank savings accounts.

"The simple message is -- the economy is doing well." Federal Reserve Chair Janet Yellen said at a news conference. "The unemployment rate has moved way down and many more people are feeling more optimistic about their labor prospects."

The Fed’s rate hike Wednesday is likely to have the biggest and most rapid effect on short-term interest rates for auto loans and credit cards, exerting a lesser impact on longer-term loans such a 30-year mortgages.

With the Fed more confident that inflation is moving higher, "It's now going to switch to more regular, more predictable path of rate hikes," says Ken Matheny, senior economist at Macroeconomic Advisers.

By historical standards, the new rate is very low rate and the projected increases are gradual. But they represent a veritable sprint based on recent experience and come amid a dwindling supply of available workers and accelerating wage growth. Those developments are raising concerns among some economists that the Fed is at some risk of falling behind an eventual surge in inflation.

The central bank hadn’t lifted its key rate since 2006 – a year that featured four quarter-point hikes -- until it acted in December 2015, and then it waited until this past December to move again amid a variety of global and domestic headwinds. Now, it’s on a roll.

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The Fed left its forecast for the federal funds rate unchanged, projecting two more quarter-point increases in 2017 and three next year, based on policymakers’ median estimate. By the end of 2019, the rate is projected to be at its long-run level of 3%.

In a statement after a two-day meeting, the Fed acknowledged that “inflation has increased in recent quarters, moving close to (the Fed’s) 2% longer run objective.” The Fed’s preferred measure of inflation is at 1.9%, though it acknowledged that a reading it focuses on more closely -- which excludes volatile food and energy costs -- remains below its 2% target, at 1.7%. The statement added that the Fed expected still-low interest rates to lead to a “sustained” return to 2% inflation.

The Fed also upgraded its view of business investment, saying it “appears to have firmed somewhat.” And it reiterated that the labor market “has continued to strengthen,” the economy is growing “at a moderate pace” and that household spending “has continued to rise moderately.”

Policymakers maintained their 2.1% growth forecast for this year but slightly raised the projection to 2.1% from 2% for 2018. They expect the 4.7% unemployment to fall to 4.5% by the end of the year and stay at that level through 2019. The Fed left unchanged its inflation estimate at 1.9% this year and 2% for 2018, but marginally revised up its forecast for core inflation to 1.9% this year.

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The Fed’s brighter view of the economy at least partly takes into account President Trump’s proposed tax cuts and beefed-up infrastructure and military spending. But Fed officials have acknowledged it’s highly uncertain when his plan – and how much of it -- will be passed by Congress. Yellen told reporters policymakers haven't yet seen "any hard evidence" that improved business sentiment has changed their spending decisions. "Most of the business people I talked to also have been in a wait-and-see" mode, she said.  

The improved outlook also marks a stark shift from the past two years, when China’s economic troubles, the United Kingdom’s Brexit vote, the oil price crash, market volatility and slow U.S. productivity growth gave Fed policymakers pause. They repeatedly stressed that the risk of hoisting rates too early and derailing the recovery outweighed the hazards of having to catch up to inflation.

But while sluggish productivity gains are still hindering faster growth, all of the other problems at least have stabilized. The global economy has picked up and U.S. stocks are near record highs. Yellen said in a recent speech that lifting interest rates “likely will not be as slow as it was in 2015 and 2016.”

U.S. job growth was unexpectedly strong the first two months of the year, and the unemployment rate is near its 10-year low at 4.7%, though millions of Americans are still discouraged and on the sidelines or reluctantly in part-time jobs. Low unemployment already has pushed up annual wage gains to 2.8% from the 2% rate that prevailed for most of the recovery as employers compete to attract fewer available workers. Firms are ultimately likely to pass on those costs to consumers through higher prices.

In a research note, Goldman Sachs said “standard policy rules suggest that the Fed is modestly to moderately behind the curve” in terms of keeping rates high enough to temper inflation. Rapidly rising prices erodes consumers’ purchasing power.

Yellen said earlier this month she sees “no evidence” that the Fed “has fallen behind the curve.”