United States: Fed holds again in October but opens door to December rate hike
October 29, 2015
At its 27–28 October policy meeting, the Fed’s Open Market Committee (FOMC) refrained once again from making any changes to its policy, but did modify its messaging and put the possibility of an initial interest rate hike in December firmly on the table. Fed Chair Janet Yellen and several top officials have been saying for months that steady improvements in the economy would soon warrant an increase in interest rates, which have been kept at historic-lows since just after the global financial crisis hit in 2008. Similarly, many analysts have argued that despite some recent disappointing data, the economy is no longer in the crisis mode that characterized the crisis years and so an emergency monetary policy is no longer necessary. While the Fed has repeatedly refrained from making a move during this year amid concerns regarding the domestic and global economies, its latest statement suggests that confidence in the health of the economy is increasing and that the much-awaited hike could very well be just around the corner.
The Fed’s accompanying statement after the latest meeting in October was substantially changed compared to previous meetings’ statements. The Fed reiterated that the economy has continued to expand at a moderate pace but emphasized that growth in household spending and business investment has been more solid in recent months. Officials acknowledged that recent job gains have disappointed, but pointed out that on balance the labor market continues to strengthen. Moreover, after having highlighted the significant risks presented by global economic and financial developments in September, this time around the Fed simply stated that it would continue to monitor these issues.
In terms of price developments, the Fed explained that inflation has, “continued to run below the Committee’s longer run objective,” due in part to the effect of low energy prices and weak prices for imported goods. Market-based measures of inflation are low and survey-based measures of longer-term inflation expectations remain stable. The effects of lower energy and import prices are projected to dissipate and inflation is still expected to rise toward 2.0% over the long term. An interest rate hike is becoming more likely as Fed officials grow more confident that rising inflation is on the horizon. However, given the currently-low price environment, a decision will hinge largely on inflation expectations, which in turn are driven by expectations for ongoing economic recovery.
The FOMC confirmed that the federal funds target rate would remain within the current range of between 0.00% and 0.25% for the time being. However, monetary officials revised their forward guidance. For quite some time the Fed has stated that progress towards achieving maximum employment and target inflation would determine how long they would keep rates unchanged. In a major revision to its language, this time the Fed specifically mentioned its next meeting as a reference for a potential change in rates. While not committing to a hike, the modification in language confirms that the Fed is considering a December move. Market expectations for a rate hike in December will likely increase between now and then unless data on the economy are very disappointing. Regardless of when the first rate hike is implemented, the pace of subsequent rate hikes is expected to be quite gradual.
Author: Carl Kelly, Economist