Unlike most meetings, today’s actions by the Federal Reserve were chock full of implications for the future course of monetary policy. At long last, the Fed finally removed the language in its statement that short-term interest rates will remain at essentially zero for a “considerable time” and replaced it with language that the Fed will be “patient” before starting to increase rates.

Several months ago, Fed Chair Janet Yellen let it slip that she thinks a “considerable time” means about six months. As a result, we are increasingly confident in our forecast that the first rate hike will come by June 2015, six months from now.

What’s striking about the rest of the Fed’s policy statement is how focused it is on the labor market, altering the wording of its statement as well as its economic projections slightly here and there to signal its own increased confidence in job creation and declining unemployment.

The obsession with the labor market helps explain why the Fed was willing to look past the recent oil-induced drop in overall inflation. Remember, the Fed doesn’t care as much about where inflation is today as where its own models are projecting inflation to go over the next few years. And while it expects inflation to remain low for the time being, it sees this as temporary and that one of the reasons inflation will rebound is improvement in the labor market. The Fed may be the most ardent advocate of the Keynesian Phillips Curve in the world.

When the Fed starts raising rates it is unlikely to raise rates at every meeting, as was done in the past two prolonged rate hike cycles under Alan Greenspan in the late 1990s and Ben Bernanke in the middle of the prior decade. Yellen cautioned against this view at the press conference following the meeting. In addition, the “dot matrix” showing where policymakers think interest rates will go over the next few years suggests the Fed will, for the first year of rate hikes, alternate between raising short-term rates at one meeting and then pausing at the next, making for one rate hike of 25 basis points per quarter through mid-2016.

The “median” dot may suggest a slightly faster pace of rate hikes, but we’re guessing that, as the leader of the Fed, Yellen will ultimately get her way and she is probably on the dovish side of the dot matrix. With the highest dot being the most hawkish, Yellen is probably around dot number 12, give or take, and that dot shows three rate hikes in 2015 and six in 2016.

Another issue is when the Fed’s balance sheet will go back to normal. We’re still forecasting that the Fed will keep reinvesting principal payments from its asset holdings to maintain the balance sheet at roughly $4.4 trillion through at least late 2015.

Notably, this last meeting for 2014 must have been a contentious one. Three members dissented. Once again, Minneapolis Fed president Narayana Kocherlakota disagreed from the dovish side, saying inflation was too low. The two other dissents were from hawks. Dallas President Richard Fisher thought rate hikes should come earlier and Philadelphia President Charles Plosser thought the statement was too focused on the timing of rate hikes rather than the economic conditions that would generate rate hikes. In addition, Plosser thought the statement was not optimistic enough.

The bottom line is that while the Fed is still behind the curve, it’s at least finally pointed in the right direction, and, barring some major shift in its outlook for the economy, the clock is ticking on rate hikes. Nominal GDP – real GDP growth plus inflation – is up 4.0% in the past year and up at a 3.9% annual rate in the past two years. A federal funds target rate of nearly zero is too low given this growth. It’s also too low given well-tailored policy tools like the Taylor Rule.

In the meantime, hyperinflation is not in the cards; the Fed will keep paying banks enough to keep the money multiplier depressed. But, given loose policy, we expect gradually faster growth in nominal GDP for the next couple of years. In turn, the bull market in equities will continue and the bond market is due for a fall.

This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy. 

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