United States: Fed more upbeat but still cautious about economic recovery, first rate hike expected later this year
June 18, 2015
At its 16–17 June policy meeting, the Fed’s Open Market Committee (FOMC) stated that the economy has returned to moderate growth after a notably weak performance in the first quarter. Despite the momentum gain, Chair Janet Yellen explained in a post-meeting press conference that the committee, “would like to see more decisive evidence that moderate pace of economy activity can be sustained” before boosting the federal funds rate. The Fed has been avoiding a fixed road map for hiking rates amid worries that a premature rate hike will threaten a recovery that has taken years to solidify. Nonetheless, projections from Fed committee members reinforce the idea that a first rate hike will take place at one of the three remaining meetings this year. Moreover, while the debate among market analysts has long been dominated by when the first rate hike will take place, questions regarding the pace of subsequent hikes are now attracting equal attention.
The Fed’s accompanying statement gave a more upbeat assessment of the economy compared to its last meeting. In addition to the aforementioned moderate economic expansion, latest data show that gains in the labor market have picked up and the unemployment rate held steady. Household spending has also showed signs of a recovery. In contrast, business investment and export growth remain in a soft patch.
In terms of price developments, monetary authorities explained that inflation has, “continued to run below the Committee’s longer run objective,” due to the lagging 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. However, the effects of lower energy and import prices are projected to dissipate and inflation is still expected to rise toward 2.0% over the medium term. Committee members kept their inflation forecast for this year at a range of 0.6%-0.8%.
In order to continue fostering growth in the economy and stoke inflationary pressures, the FOMC confirmed that the federal funds target rate would remain within the current range of between 0.00% and 0.25%. The Fed is confident that this accommodative policy will help economic output stay on an expansionary path and further strengthen the labor market.
Looking forward, the Fed emphasized once again that decisions to hike the rate still depend on the assessment of a “wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.” The Committee stated that it will not raise rates until there have been further improvements in the labor market and until it is “reasonably confident that inflation will move back to its 2.0% objective.”
While the Fed continues to affirm that its decision is dependent on economic developments, the stage seems set for a rate hike later this year. In fact, 15 of 17 committee members believe that it will be appropriate to make a rate policy change some time this year. The median projection made by committee members in a supplementary document released after the meeting is for the federal funds rates to be at 0.625% at the end of this year, which is unchanged from the median projection made in June. The Fed has three more scheduled meetings this year, in September, October, and December.
As a first rate hike becomes more likely, questions regarding the pace of hikes are surfacing. At the follow up press conference, Yellen commented that, “too much attention is placed on the timing of the first increase in the federal-funds rate. What should matter to market participants is the entire expected trajectory of policy.” This comment should stoke the debate about how quickly rates will be increased. The median projection is for rates to reach 1.625% by the end of 2016, which is below the 1.875% median projection from June. The median projection for 2017 slipped from 3.125% to 2.875%. These updated projections suggest that the pace of rake hikes after the initial move will be more gradual than anticipated earlier.
Author: Carl Kelly, Economist