Interest rates have risen recently due largely to how financial markets have interpreted comments from Federal Reserve (Fed) presidents and minutes of the last Federal Open Market Committee (FOMC) meeting that were released. The question is whether the rise in interest rates is based on perception or reality. My vote is that it has been a reaction created by the market’s perception that the Federal Reserve has changed their stance regarding the timing of interest rate increases. I believe that the reality is that they have not changed their stance but were trying to recalibrate market expectations.
Let’s take a look at what the Fed said and what the economic data has told us since the last FOMC meeting.
Atlanta Federal Reserve President Dennis Lockhart and San Francisco Federal Reserve President John Williams both gave speeches in front of the release of the April FOMC meeting minutes. In their speeches they warned the financial markets that they may be underestimating how many interest rate increases could occur this year. They also stated that they believed that an interest rate increase at the June FOMC meeting was on the table and open for discussion, depending on how the economic data played out. The reaction from the financial markets was essentially “Uh oh, is there something in the upcoming minutes that we do not know about? Are they giving us a prelude to a surprise in the minutes?” As a result of this perception, interest rates began to rise. On Wednesday (5/19/16) the Fed released the minutes from their April 26-27 meeting. There are 13 pages of those minutes and yet the financial market chose to focus on these 55 words:
“Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June”.
The financial markets responded negatively to those words and interest rates rose further.
So, let’s focus on reality. If we pay attention to the conditions that the Fed laid out in those 55 words, have the conditions been met?
Based on reality, the criteria that the Federal Reserve laid out for considering an interest rate increase in June have not been met. Whether we see a surge in strength over the next 30 days remains to be seen.
So, why would the Fed make comments that roiled the financial markets? This is one man’s opinion (mine) and do not necessarily reflect the views of Washington Trust Bank or senior management. My scenario is this:
Page 11 of the minutes contained this note:
“Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.”
I believe that the Fed speeches and the minutes were both attempts to recalibrate financial market expectations regarding the timing of interest rate increases.
Recent Federal Reserve communications and the financial markets’ reaction to the communications indicates that “Fed Speak” remains an “arrow” in the Fed’s monetary policy tool “quiver” when they want to adjust the financial markets’ perception to be closer to what the Fed views as reality.
Steve Scranton is the Chief Investment Officer and Economist for Washington Trust Bank and is a CFA charter holder with over 30 years of investment experience with equities, tax-exempt and taxable fixed income securities. Steve actively participates on committees within the bank to help design strategies and policies related to client and bank owned investments. Steve also serves as the economist for the Bank and has been a featured speaker for both client and professional organization events throughout the Northwest.