Key Points
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The Fed raised rates by 25 basis points this week, for the third time this year, which was widely expected.
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There were only minor changes to the Fed’s projections; however the long-run neutral estimate of the fed funds rate did inch up; while the “accommodative” language was eliminated from the Fed’s statement.
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Updated expectations are now that the Fed will hike once more this year, and three times next year, in keeping with an upgraded economic outlook.
The Federal Open Market Committee (FOMC) surprised no one today and raised rates for the third time this year in a unanimous decision. The Fed reaffirmed the expectation that another hike is on the table this year, and three more hikes are likely in 2019, based on the so-called “dots plot.” There were some defections among FOMC members from three to four hikes expected this year, which cemented the likelihood of another rate hike in December. The move brought the federal funds rate to a target range of 2-2.25%. The FOMC’s statement contained a reiteration of its upbeat assessment of the U.S. economy, and did not mention concerns about trade potentially halting rates’ upward trajectory. Stocks rallied and longer-term bond yields retreated in the immediate aftermath of the announcement.
The statement did have a change, which was somewhat expected: dropped was the long-standing description of monetary policy as “accommodative” in reflection of rates having moved closer to the so-called “neutral” level which neither constrains nor boosts the economy. Fed officials repeated their assessment that “risks to the economic outlook appear roughly balanced.” However, during the post-FOMC meeting press conference, Fed Chair Jerome Powell did use the word “accommodative” to describe “overall financial conditions.”
The Fed also released new forward-looking projections for the economy. The median forecast continues to show that short-term rates will reach 3.4% in 2020 (no change from June’s projections). But the new projections now include a look into 2021, when the Fed expects the fed funds rate to remain at 3.4%. The median long-run neutral estimate did move up slightly, from 2.9% to 3.0%. The Fed also updated its projections for the economy, unemployment and inflation; all seen below. It was the eighth consecutive time the Fed has had to upgrade its projections.
Summary details of rate and economic projections
Federal funds rate estimates: 2018 unchanged at 2.4%
2019 unchanged at 3.1%
2020 unchanged at 3.4%
Longer run up to 3.0% from 2.9%
Median GDP growth estimates: 2018 up to 3.1% from 2.8%
2019 up to 2.5% from 2.4%
2020 unchanged at 2.0%
2021 projected at 1.8%
Long-run unchanged at 1.8%
Median unemployment rate estimates: 2018 up to 3.7% from 3.6%
2019 unchanged at 3.5%
2020 unchanged at 3.5%
2021 projected at 3.7%
Long-run unchanged at 4.5%
Median core PCE inflation: 2018 unchanged at 2.1%
2019 unchanged at 2.1%
2020 unchanged at 2.1%
2021 projected at 2.1%
Based on recent GDP figures, the “output gap” (difference between actual and potential growth) has closed, which historically has tended to usher in higher inflation. The unemployment rate (as reported by the Bureau of Labor Statistics) is 3.9%—below the Feds 4.5% estimate of the sustainable level—while the “underemployment” rate has fallen to its lowest level since 1999 (and the number of people working part-time but who want full-time work has fallen to a new cyclical low). Moreover, the spread between the two readings is at the lowest level since 2006.
Average hourly earnings (AHE) are picking up; albeit at a continued modest pace of 2.9% year/year—which means wages are just keeping up with inflation. This suggests limited urgency on the part of the Fed at this stage. In addition, the labor force participate rate remains historically low; but is at least partly due to factors outside the Fed’s influence sphere, including demographics.
During the press conference following the FOMC announcement, many of the questions were about trade/tariffs and when/if the Fed expects to see the impact on actual economic numbers vs. just surveys and corporate commentary. Chairman Powell conceded that the central bank is hearing a “rising chorus” of concern about tariffs specifically, and protectionism more broadly, so this will likely remain a topic to be addressed in future Fed officials’ speeches and comments. Surprisingly, there was no attention given to the ongoing shrinking of the Fed’s still-behemoth balance sheet.
In sum, the decision on rates and the accompanying statement reinforces an upbeat assessment of the economy; but a need to remain vigilant with inflation (and trade risks). The removal of the “accommodative” language is seen as giving the Fed more flexibility both in future actions as well as communications.
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