Key Points
- The lack of a rate hike was not the big surprise, but the still-dovish accompanying statement was.
- Recent global economic and market turmoil appear to have been the proximate cause for the punt, although still-low inflation gave the Fed cover as well.
- We believe the Fed will act this year; but that the pace of hikes will be very slow relative to recent history.
The Fed opted to stall on raising rates for the first time since 2006; primarily citing global turmoil and still-restrained inflation for its decision. In addition, the accompanying Federal Open Market Committee (FOMC) statement was not as hawkish as many expected (meaning, those who had been expecting no hike, were also expecting a more hawkish statement).
The FOMC did acknowledge the improvement in economic and job growth; specifically addressing labor market slack: “On balance, labor market indicators show that underutilization of labor resources has diminished since early this year.” But it also noted the still-very low levels of inflation and global turmoil, which remain a concern: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
The main, not-so-hawkish sentence in the statement released by the Federal Open Market Committee: “The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” The blandness of that, in relation to its statements in the past, likely means some of the uncertainty around Fed policy will be with us at least until the next FOMC meeting in October.
Down but not out
Immediately after the statement was released, the probabilities traders assign a rate increase at coming meetings moved lower. According to Bloomberg, yesterday the chances for October and December were at 44% and 64%, respectively. Now they are 32% and 56%, respectively. But it remains the case that a plurality (13 of 17) of FOMC members still anticipate hiking rates by year end; with three members now in the 2016 camp and one in 2017. In addition, one member thinks the next rate move should be a cut to negative rates.
The vote to keep rates unchanged had only one dissenter—Federal Reserve Bank of Richmond President Jeffrey Lacker, who wanted to raise rates by 25 basis points.
Dots plot
The now famous “dots plot” had some changes; including a new year-end 2018 estimate. You can see the chart below, which highlights where the Fed was a year ago (blue line), where the Fed is now (maroon line), and where the market’s expectations sat (yellow line) immediately post-meeting today.
Source: Bloomberg, Federal Reserve. Fed estimate based on median Federal Open Market Committee (FOMC) projections.
Market estimate based on Bloomberg Euro Dollar Synthetic Rate Forecast Analysis (EDSF).
Rate and economic projections
In addition to the Fed publishing its new assumptions, the emphasis is now on “median” rather than “central tendency” calculations:
Fed funds rate (lower): The median fed funds rate projection for year-end 2015 is now 0.375% instead of 0.625%. The median for year-end 2016 is now 1.375%, down from 1.625%. The median for year-end 2017 dropped to 2.625% from 2.875%. And the new median for year-end 2018 is 3.375%. The Fed also lowered its estimate for the longer-run normal fed funds rate to 3.5% from 3.75%.
Unemployment rate (lower): The median for the unemployment rate in this year’s fourth quarter is now 5.0%, down from 5.3%. By the fourth quarter of 2016, the Fed expects a 4.8% rate instead of a 5.1% rate. By the fourth quarter of 2017, the rate is expected to be 4.8%, down from 5.0%. And, included for the first time, the expectation is also for a 4.8% unemployment rate by the end of 2018.
Inflation (higher-then-lower): The 2015 median for the rise in core personal consumption expenditures (PCE) prices is 1.4%, instead of 1.3%. For 2016 it’s 1.7%, down from 1.8%. For 2017 it’s 1.9%, down from 2.0%. And 2018 has been set at 2.0%
Real GDP (higher-then-lower): The median for 2015 real GDP growth is now 2.1%, up from 1.9%. For 2016, it’s 2.3%, down from 2.5%. For 2017, it’s 2.2%, down from 2.3%. And 2018’s median is 2.0%. The median for longer-run normal real GDP growth is unchanged at 2.0%.
Markets’ immediate reaction
Within the first few minutes after the announcement, US stocks took it on the chin, but then rallied sharply over the next 45 minutes; after which it pared its gains. Emerging market stocks also fared well on the news. Away from equities, Treasuries rallied, 2-year note yields fell the most in six months, while the US dollar fell to a three-week low.
Now we will go back to the fretting about the Fed’s timing and the interim data which will be sliced and diced. Our view is the Fed won’t necessarily wait for inflation to be above its 2% target, but it would like to see a reversal from its latest move lower. Wages—which remain restrained—will also likely have to perk up before the Fed acts. And an easing in both global turmoil and attendant volatility would support a hike this year.
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