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Fed raises rates for the second time in a decade

Federal Reserve officials, amid signs that the U.S. economy soon could shed its long period of stagnation, approved the first interest rate hike in a year Wednesday and said it foresees three more increases next year.

The stock market reacted calmly, while bond yields and the dollar rose. The yield on 2-year Treasurys hit its highest level in since August 2009.

The Federal Open Market Committee raised its target range from a range of 0.25 percent to 0.5 percent to 0.5 percent to 0.75 percent. The overnight funds rate currently sits at 0.41 percent.

The committee also approved a quarter-point increase in the discount, or primary credit, rate, from 1 percent to 1.25 percent.

The decision was unanimous. Previous meetings had featured dissents from as many as three members who felt the Fed should resume a rate-hiking cycle it began in December 2015.

In addition to approving the much-expected increase, the FOMC also indicated a higher rate than projected back in September when it last released the quarterly look ahead. The committee now expects three rate hikes in 2017, two or three in 2018 and three in 2019.

In effect, the Fed added one more hike during the entire period, with the longer-run target up to 3 percent from 2.9 percent.

"What they did was highly anticipated. There was a slight surprise in next year, looking at an additional rate hike," said Myles Clouston, senior director of Nasdaq Advisory Services. "Overall, the Fed remains pretty steady overall, looking at gradual raises in interest runs in the long run."

The closely watched dot-plot also indicated a somewhat more ambitious future for hikes.

However, the committee continued to emphasize in its post-meeting statements that the path higher will be "gradual." It also stuck with language indicating that risks to the Fed's forecasts remain "roughly balanced," and emphasized that future moves will be data-dependent rather than subject to a set schedule.

Traders work on the floor of the New York Stock Exchange (NYSE) shortly after the announcement that the U.S. Federal Reserve had hiked interest rates for the first time in nearly a decade in New York, December 16, 2015.
Lucas Jackson | Reuters
Traders work on the floor of the New York Stock Exchange (NYSE) shortly after the announcement that the U.S. Federal Reserve had hiked interest rates for the first time in nearly a decade in New York, December 16, 2015.

The increase came with projections that economic conditions are changing.

On inflation, the committee said market-based measures remain low but have moved up "considerably," a word that was omitted from the November statement.

On the jobs market, Fed officials indicated that full employment is getting closer.

"The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a return to 2 percent inflation," the statement said.

That differed from November, when they included the more definitive "supporting further improvement in labor market conditions" language. There has been considerable discussion within the Fed about how close the labor market is to full employment, and this week's developments indicate that officials believe that condition is getting closer.

The move came with an incrementally more upbeat look at the economy. This week's statement said "economic activity has been expanding at a moderate pace since mid-year," an upgrade from November's assessment that growth had "picked up from the modest pace seen in the first half of this year."

Committee members lifted their expectations for GDP growth from 1.8 percent in 2016 to 1.9 percent, and 2.1 percent in 2017 against the previous estimate of 2.0 percent. However, 2018 remained at 2.0 percent while 2019 also was bumped up a notch, from 1.8 percent to 1.9 percent. The longer-run GDP projection remained at 1.8 percent.

Headline inflation expectations were little changed overall, with 2016 moved up from 1.3 percent in September to 1.5 percent in Wednesday's projections, but the longer-run outlook remained at 2.0 percent.

The Fed last hiked rates almost a year ago to the day — Dec. 16, 2015, to be exact — during a decidedly different time for the economy. GDP growth for the fourth quarter of 2015 was just 0.9 percent, and it was far from certain that inflation was heading toward the central bank's 2 percent target.

Markets initially welcomed the news then but then nose-dived, sending major stock averages just short of bear market territory in what would become a topsy-turvy year for geopolitics and growth.

A year later, things have changed significantly.

The economy has continued to trek toward full employment, with the jobless rate currently at 4.6 percent. Most inflation measures show the trend much closer to the Fed's benchmark as well.

The Dallas Fed's one-month trim mean inflation rate, for instance, is now at 2.1 percent.

Despite the Fed's tepid optimism, there is a growing feeling on Wall Street that growth both in GDP and inflation could surprise higher. For instance, Harvard economist Ken Rogoff said this week that economic gains under President-elect Donald Trump could be "significantly faster" than have been the case during the post-recession period.

"What's more interesting is what's going to happen next year," said Ed Keon, portfolio manager and managing director at QMA. "With the pro-growth agenda of the Trump administration, how will the Fed react to that?"

Trump's victory has brought with it hopes that fiscal loosening in the form of perhaps $1 trillion in infrastructure spending will spur growth. The stock market has posted a powerful rally during the postelection period, bringing with it a sharp climb in government bond yields.

Economic indicators have picked up in recent months, though news Wednesday that inventories declined dampened expectations for the fourth quarter. The Atlanta Fed now believes fourth-quarter growth will be 2.4 percent, down from 2.6 percent last week, and several other economists also pared back expectations for the current period.

The December 2015 hike was ite FOMC's first hike in more than nine years. The committee took the rate to zero during the financial crisis in 2008.