The FOMC delivered on the expected 25-basis-point increase in its target range for the federal funds rate and has penciled in three more rate hikes for 2018. Of course, all of this future activity is “data-dependent.” How likely is it that the data will justify those three rate hikes, and what could go wrong?

First, the good news keeps coming. Keep in mind that in December the FOMC had only lagging hard information on GDP growth in Q1–Q3 of 2017. They did have fragmentary anecdotal information on Q4 and monthly data on spending and employment. Virtually all that information was positive. There were over 225K jobs created in both October and November. New claims for unemployment insurance during this quarter are about 20K lower than in the third quarter.¹ The unemployment rate was 4.1% for the past two months and FOMC forecasts have it moving even lower.² In October consumer spending posted its biggest gain since 2009, driven in part by replacement of autos and cleanup spending in the wake of the hurricanes. Inventory investment is up, and this trend signals additional expectations of future sales, given the strength of real GDP growth, rather than an unanticipated accumulation of unsold goods. Finally, the Atlanta Federal Reserve Bank’s GDPNow forecast suggests that Q4 growth will be 3.3%, the third quarter in a row with GDP growth in excess of 3%.³ All of this suggests that we go into the New Year with an improving real economy.

As for what the Fed has been doing to reduce the size of its portfolio, from September 28 to December 13, the system’s total holdings of Treasuries, agencies, and MBS have declined by only $1.5 billion, less than might have been expected given the plan put forward by the FOMC. Interestingly, the Fed’s holdings of MBS have actually increased by $12.1 billion, according the Board of Governors’ H.4.1 reports.⁴ These small asset adjustments have not had much effect on the term structure. The short end of the Treasury curve moved up before the FOMC December meeting, largely in anticipation of the rate hike; but following the meeting there was a flattening of the long end of the Treasury curve by some 11 bps on the 20-year and by about 18 bps on the 30-year. This flattening continues a trend for 2017, where the spread between the two-year and ten-year Treasury has declined from about 128 bps to about 56 bps.