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Fed hikes The Fed and Wall street Differ on How High Rates will go- Bloomberg

The Fed damaged its credibility over the past half-decade by repeatedly stating that it expected to raise interest rates, only to back down when stronger growth failed to materialize, Bloomberg reported.

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Janet Yellen, Chair of U.S Federal Reserves play

Janet Yellen, Chair of U.S Federal Reserves

On Dec. 16, the U.S Federal Reserve hiked interest rates for the first time since the 2008 economic meltdown,  signaling faith in the U.S economy.

"With the economy performing well and expected to continue to do so, the committee judges that a modest increase in the federal funds rate is appropriate," Fed Chair Janet  Yellen said in a press conference after the rate decision was announced. "The economy recovery has clearly come a long way."

The Federal Reserve is indicating that it will raise interest rates four more times before the end of 2016, but Bloomberg reports that traders in the financial markets don’t believe it. They’re expecting just two more hikes in the coming year. The Fed’s lack of believability on rates could complicate its job of steering the U.S. economy next year and beyond.

The Fed damaged its credibility over the past half-decade by repeatedly stating that it expected to raise interest rates, only to back down when stronger growth failed to materialize, Bloomberg reported.

According to the report, traders made easy profits by betting against the central bank, defying an old maxim on Wall Street—“Don’t fight the Fed.” Now Fed Chair Janet Yellen and the rest of the monetary policymakers have to persuade the financial markets that this time, they really, really mean it.

Explaining in depth why the Fed and the market differ on how the rate will go, Bloomberg noted: "The Fed’s own expectations for rates are set out in the periodically released “dot plot.”

Each dot in this chart represents a forecast for the fed funds rate by a member of the FOMC.

The panel consists of the people on the Federal Reserve Board in Washington, currently five, and the presidents of the 12 regional Federal Reserve Banks. The committee members are asked to make forecasts for the end of each year. The identity of the person associated with each dot is not revealed.

In the forecast that was released on Dec. 16, the median FOMC member—i.e., the one whose dot was in the center of the cluster—predicted a federal funds rate of 1.25 percent to 1.5 percent at the end of 2016. That amounts to four hikes, assuming each is a quarter point."

One reason for the gap between the Fed and the markets is purely mechanical: The Fed voters were instructed to pick the single most likely level for the interest rate, whereas the financial markets take into account the entire range of possible outcomes, including the chance of a recession in the coming year that would drag the rate down.

Beyond that, the gap shows that participants in the financial markets, correctly or not, don’t believe that the Fed will raise rates as fast as it says. To justify higher rates, the Fed will need to see stronger economic growth and a rise in the inflation rate, which is below the Fed’s target of 2 percent.

Credit- Bloomberg

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