Federal Reserve Appears to Remain on Course to Begin Raising Short-Term Interest Rates in the Fourth Quarter

The Federal Reserve’s Federal Open Market Committee (FOMC) concluded their two day meeting and gave no new guidance as to when they will begin raising short-term rates. The statement was identical to last month’s statement except for the first paragraph. The first paragraph changed their description of several items:

• Economic activity:
  1. The wording changed from “…economic growth slowed during the winter months.” to “…economic activity has been expanding moderately after having changed little in the first quarter.”
• Labor underutilization:
  1. The wording changed from “…the underutilization of labor resources was little changed.” to “…the underutilization of labor resources diminished somewhat.”
• Household spending:
  1. The wording changed from “Growth in household spending declined…” to “Growth in household spending has been moderate…”
• Housing
  1. The wording changed from “…the housing sector has remained soft…” to “…the housing sector has shown improvement…”

They continued to say that the current range for Fed Funds (0-.25%) is appropriate to support continued progress toward their two mandates: maximum employment and price stability. What is interesting is that the FOMC members lowered their expectations for where short-term rates will be next year. They dropped the central tendency from 1.875% to 1.625% for next year. This is consistent with my view that the pace of increase will be slower than historical rate increases. The FOMC members believe that once the “transitory” effects of lower oil and cheaper imports wash through the economy, inflation will rise back toward their expectation of 2%.

The FOMC emphasized that their decision on when to start the process of normalizing rates (i.e. begin raising the Fed Funds rate) is dependent on the trends of the economic data and inflation. All but two of the FOMC members project that the Fed will to start raising rates in the fourth quarter. Two members project the increase to start in 2016. Chairman Yellen spent most of her time in her press conference refusing to be pinned down with a specific forecast of when she thinks the Fed will begin to raise rates and reminding everyone that the decision of when to raise rates is not predetermined. She was clear that the Fed is not following any type of mechanical approach in determining when to raise rates and what pace to follow once they start rate increases. The message remained that the trend of economic growth and inflation will be reviewed at each meeting and decisions will be made based on the trends.

Overall, the Fed appears to be building its case that first quarter economic growth was an anomaly and that the economy is gradually improving. Unless we see a downturn in economic activity through the summer, 4^th quarter still appears to be the point when the Fed will decide to raise rates.

 

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