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In a unanimous decision, the Federal Open Market Committee decided not to initiate liftoff in June. This should come as no surprise. Looking back, the April FOMC statement, coupled with first-quarter gross domestic product numbers, reduced the chance of a June rate hike to almost nothing—this despite a pickup in economic data in the past few weeks.
Highlights of the Fed’s Latest Communications
The Fed is trying not to make headlines. The June FOMC meeting statement was designed to make little news. It was concise—only 505 words compared to 520 words in April. The language was largely identical to the April statement, with the biggest differences arriving in the first paragraph, where policymakers discussed changes in the macroeconomic backdrop. This section confirmed that the slowdown in economic growth and labor developments during the first quarter of the year was transitory.
A more positive view of the economy. The Federal Reserve recognizes that the economy has picked up moderately in the second quarter following a very disappointing first quarter. However, that has not translated into an improvement in economic projections by individual FOMC participants. GDP growth projections for 2015 were actually revised down from 2.3%-2.7% to 1.8%-2.0%, likely reflecting the poor first quarter.
Liftoff timing is still vague. The FOMC was less specific than it could have been about when liftoff is likely to occur, even though it seems likely that the start date will be September. Fed Chair Janet Yellen made it clear in the press conference following the announcement that she does not want to specifically communicate when a rate hike will occur because it is “data dependent”—and market participants are seeing the same data she and the other FOMC participants are seeing so they can discern for themselves when liftoff will begin.
A close eye on overseas developments. Clearly, international considerations are playing a role in the Fed’s deliberations—and they received a mention in today’s announcement: “This assessment will take into account 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.” It has become increasingly clear that the Fed can’t entirely ignore the unfolding crisis in Greece, given the volatility it is creating. In addition, the Fed must at least give a nod to other developments, such as calls by the International Monetary Fund and World Bank to forego any rate hikes in 2015.
More than one rate hike this year? The “dots,” which indicate individual FOMC participants’ policy prescriptions of where they believe rates should be at year–end, suggest that there will be at least one interest-rate hike this year (15 out of 17 FOMC members deem it appropriate given their economic expectations). However, the median of the rate projections for end of year 2015 is 0.63%, suggesting there will likely be two rate hikes this year. It is important to note that the mean recommendation for the federal funds rate for the end of 2015 is now 0.57% compared to 0.77% in March and 1.13% when the Fed met in December 2014. This indicates that FOMC participants believe the path of rate hikes will be lower than they expected just a few months ago.
Unemployment expected to improve, but at a slower pace. Policymakers increased their projection for 2015 unemployment, from 5.0%–5.2% to 5.2%–5.3%. While continued progress toward full employment was noted in both the FOMC statement and in Yellen’s press conference, a slower-than-expected decline in unemployment may give the Fed breathing room during the policy normalization process.
Path of rate hikes more critical than timing. As we expected, Yellen stressed in the press conference that the path of rate hikes is far more important than when the initial liftoff will occur—and that, given the Fed’s current economic expectations, normalization should be gradual. She suggested rates may rise 100 basis points per year, but that there was no reason to expect rates to move in 25-basis-point increments like they did during the 2004-2006 rate-hike cycle. She reiterated that due to lingering effects from the financial crisis, it is likely that rates will remain below the Fed’s “neutral” level even after inflation and employment levels approximate the Fed’s policy objectives.
Inflation remains a hot topic. In her press conference, Yellen noted that the current bout of low inflation is, in part, attributable to transitory factors including weak energy and import prices. With oil prices and the value of the dollar stabilizing, she expects these dynamics to wash out, allowing inflation to move northward from today’s exceptionally low levels. However, she noted that wage growth still remains “subdued.” Policymakers left their 2015 inflation projections untouched, with headline prices expected to rise 0.6%-0.8%, and with core prices expected to increase 1.3%–1.4%.
The Bottom Line
If economic data remain on the current path, then it seems very likely the Fed will initiate liftoff in September. We must recognize that the Fed will act in advance of reaching its goals, as Yellen made clear in a March speech: “…policymakers cannot wait until they have achieved their objectives to begin adjusting policy.” That means there could be a situation where the Fed’s actions seem out of sync with current economic data. Simply put, the Fed is taking a long-term view of monetary policy.
The implications for investors remain relatively unchanged from our previous analysis:
- Despite the changing economic environment, money and bond markets still don’t appear to be priced for the start of Fed tightening.
- We expect both stocks and bonds to be volatile, but we believe the greater risks lie with bonds.
- Bonds are likely to exhibit more volatility as we near liftoff—particularly given the global economic environment.
- We remain concerned about poor bond-market liquidity, which could also contribute to more volatility as we approach liftoff.
- While volatility may also affect equities, stocks should see support from an improving economy and better consumer spending.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
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