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How Markets Reacted to the Fed’s Hawkish Stance

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The Fed raises rates

As was widely expected, the Fed raised interest rates by 25 basis points yesterday, to 1.75%–2%. The latest hike marks the seventh time the Fed has raised rates since it started monetary tightening in December 2015, and the second time this year. While the hike itself was largely expected by the market, it was interesting that the Fed now expects two more hikes this year.

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More hawkish than expected

Fed chairman Jerome Powell sounded optimistic after the meeting, stating that the economy is reaching a “normal” level post-2008 financial crisis. He cited strong economic health and lower unemployment rates as the reason for the latest decision. The Fed is now expecting the economy to grow 2.8% this year rather than 2.7%, as it forecast in March. It is also more optimistic about the unemployment rate, which it expects to fall to 3.6% by the end of the year, rather than 3.8%. The Fed raised its headline inflation forecast from 1.9% to 2.1% for 2018. Fed officials continue to see three more hikes in 2019 but have reduced their forecast for 2020 from two hikes to one.

Impact on financial assets

As the Fed’s monetary policy statement was more hawkish than expected, major indexes fell close to session lows. The Dow Jones Industrial Average (DIA) (DOW) fell 119.5 points (0.44%) while the S&P 500 (SPY) (SPX) fell 0.32%. Both indexes recorded their largest one-day declines this month. The iShares 7-10 Year Treasury Bond ETF (IEF) fell 0.2% and the iShares 20+ Year Treasury Bond ETF (TLT) fell 0.3%, as debt with lower yields becomes less attractive in a higher rate environment. The US dollar index (UUP) strengthened by 0.2%. Gold (GLD), which usually becomes less attractive in a higher interest rate environment because it doesn’t bear interest, surprisingly closed with a modest gain of 0.3%. However, in electronic trading, gold fell to under $1,300 per ounce.

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