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CNB Economic Comments March 17

March 20, 2017

To: Everyone
From: Gregory S. MacKay, Economist

Bolstered by recent increases in inflation as measured by the PCE, CPI, and PPI, along with a solid February jobs report, the FOMC increased the federal funds rate this week by .25% to a range of .75% to 1.00%. Let’s look at parts of her statement and press conference to get a feel for the increase.

On the overall economy: Chair Yellen stated: “Overall we continue to expect that the economy will expand at a moderate pace over the next few years.” Nothing new there.

On consumers: “Solid income gains and relatively high levels of consumer sentiment and wealth have supported household spending growth.” Sentiment is good, but January credit usage was weak, and the February retail sales report was mixed, and weaker than January.

On jobs: “Job gains averaged about 200,000 per month over the past three months, maintaining the solid pace we have seen over the past year.” Absolutely.

On jobs, part two: “Participation in the labor force has been little changed, on net, for about three years. Given the underlying downward trend in (labor) participation stemming largely from the aging of the U.S. population, a relatively steady participation rate is a further sign of improving conditions in the labor market. We expect job conditions will strengthen somewhat further.” This is an important statement that minimizes many past statements of a “problem” in the labor participation rate, effectively taking the rate off the board because of the realization that many baby boomers are retiring.

On inflation: “The 12 month change in the price index for personal consumption expenditures (PCE) rose to nearly 2% in January, up from less than 1% last summer. That rise was largely driven by energy prices. Core inflation – which excludes volatile energy and food prices and tends to be a better indicator of future inflation – has been little changed in recent months at about 1¾%. We expect core inflation to move up and overall inflation to stabilize around 2% over the next couple of years, in line with our longer run objective. It appears the FOMC sees more inflation coming, even though energy and food prices have stabilized.

On economic projections:
Median GDP growth for 2017 and 2018 is 2.1%, and 1.9% in 2019.
Median unemployment projection is 4.5% for the next 3 years.
Median core PCE inflation projection is 1.9% this year and 2% in 2018 and 2019.
Median federal fund projection is 1.4% at year-end 2017, 2.1% at year-end 2018, and 3% at year-end 2019.
My comments: first, these are little changed from December projections, suggesting the FOMC is most satisfied with the current pace of the economy. Secondly, a 1.4% median federal funds rate suggests two more increases this year.

On shrinking the Fed’s balance sheet: Chair Yellen again stated that the fed funds rate is the primary tool of adjustment. She stated that there is no change contemplated yet in the reinvestment of principal and interest on securities owned, and the process of shrinking the balance sheet will happen when risk to the economy is low and confidence in the economic outlook is firm.

On fiscal policy: Chair Yellen said that there has been no detailed discussion of potential policy changes, and FOMC responses to such changes have not been considered. She said the FOMC needs to know much more about the changes and their timing to begin to estimate their possible effects on the economy, and again stated that any policies instituted by Congress and the administration that would boost productivity and growth would “be welcome changes” that the Fed would like to see.

On timing of the rate increase: In answer to a question about the FOMC move now, in the face of a weak (+.9%) GDP now forecast for the first quarters, the mixed retail sales report, and little wage inflation, Chair Yellen expressed confidence in the various projections by the participants. She said there is always “noise” in the data from quarter to quarter – perhaps a reference to the poor showing in the last several years of first quarter GDP growth – and reminded everyone that the Fed remains data dependent – changes up and down will be determined by incoming data.

Finally, Chair Yellen had a message for all consumers who are concerned about the rate hike. She said the economy is doing well. The FOMC has confidence in the robustness of the economy and its resilience to shocks, and thinks “people can feel good about the economic outlook.”

Stocks were mixed this week, with small caps doing best in a cooling climate. At the open Friday, for the week and year:

Index 03/17/17 Weekly Change Year-to-Date Change
Dow Industrials 20935 -0.3% +5.9%
NASDAQ 5901 +0.5% +9.6%
S&P 500 2383 ------- +6.3%

Treasury bonds have priced in the increase in the federal funds rate over the past couple of weeks. Municipals are still in short supply, with only small yield increases.


Return Period
U.S. Treasuries Municipal Bonds
03/17/17 02/24/17 03/17/17 02/24/17
2 year 1.33% 1.18% 1.07% 1.06%
5 year 2.04% 1.87% 1.73% 1.63%
10 year 2.53% 2.36% 2.46% 2.35%