Interest Rates Remain Low After Fed Statement, but for how long is the question?
We were pleased to see the market improve after the Fed met today to discuss their plans in the near future and the removal of the word “Patience” from their early statements in previous months. This provides the Fed with the flexibility to raise the federal funds rate any time beginning in June. The biggest surprise was that Fed officials also increased the requirements to raise rates. According to the statement, Fed officials want to see further improvement in the labor market and want more confidence that inflation will reach their target rate of 2.0% before raising rates. Adding to the time to meet the requirements, Fed officials lowered their forecasts for economic growth and inflation. Investors pushed expectations for rate hikes farther into the future.
“Since the Committee’s last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further.”
More than six years later the federal funds rate remains at this historically low level but the economic picture has changed drastically — albeit slowly. Wednesday the FOMC took a small but significant step toward beginning to raise interest rates by issuing guidance that opens up the possibility of a hike as soon as June.[wpcb id=”6″]
The committee is more optimistic about the economy than it has been in years but has dialed back its take since January. The new statement says:
Information received since the Federal Open Market Committee met in January suggests that economic growth has moderated somewhat. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. A range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow and export growth has weakened. Inflation has declined further below the Committee’s longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable.”
On the policy guidance front the change is the removal of a single word — patient. Since December 2014 the Fed has used this word in its policy statement to describe its stance on raising rates. For two meetings the statement said: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” It now says: “Consistent with its previous statement, the Committee judges that an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.”
Those two sentences have big implications. For months Fed Chair Janet Yellen and her band of economists have tried to act as financial soothsayers by carefully defining what patience – and ultimately its absence — means for monetary policy. At the same time, they’ve tried not to say too much to avoid setting a path they can’t stick to if economic conditions change.
Yellen visited Capitol Hill twice last month. There she provided the most significant insight yet into the course ahead, saying the word patient would be removed before a rate hike occurs and would signal that the committee would consider a rate hike at each subsequent meeting. Yellen had previously defined “patient” as “a couple”of meetings and agreed that “a couple” means two. In her Congressional testimony she clarified that changing the guidance meant the Fed could act in two meeting, not that it would. This sentiment was reiterated in the new statement which pointed out, “This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”
The removal of patient, therefore, means that a rate hike won’t come at the committee’s April meeting but could come in June. Prior to the release the market’s view was that a move will come in June or September. (Most people are betting the FOMC will only act at a meeting that is followed by a press conference. The Fed chair hosts press conferences at alternating meetings. The July meeting will not include a conference and there is no meeting in August.)
© Provided by Forbes Federal Reserve Chair Janet Yellen greets by a member of the House Financial Services Committee hearing on Capitol Hill last month when she delivered her twice annual testimony on monetary policy and the state of the US economy. (Photo by…
The U.S. equity market was in the red leading up to the statement release at 2 p.m. and press conference at 2:30 p.m. After the statement became public all three major stock indices swung to positive territory. Within minutes the S&P 500 was up about 0.7% to 2,089; the Dow Jones Industrial average was up 0.9% to 18,000; and the Nasdaq Composite was up 0.8% to 4,976.
Until next time! 🙂
Featured Pictures: © Jonathan Ernst/Reuters A general view of the U.S. Federal Reserve building as the morning sky breaks over Washington, July 31, 2013. The U.S. Federal Reserve likely will decide at the end of a policy meeting on Wednesday to continue buying…