Don’t be confused by the Federal Reserve acknowledging the obvious slowdown in economic growth in the first quarter. The door to a June rate hike is still open. Not wide open, but much more open than most analysts and investors think.
The Fed’s statement mentioned slower growth in output, consumer spending, business investment, exports, and job creation. But it also hinted at faster growth ahead by mentioning how lower energy prices mean faster gains in “real” (inflation-adjusted) incomes.
Other analysts may point to Fed language that the recent slowdown only “in part” reflects “transitory factors.” In turn, they may argue this means the Fed thinks some of the recent slowdown may be longer lasting. But the Fed said almost the same thing last year, stating the slowdown last winter was “in part” due to “adverse weather conditions.” That’s right before real GDP expanded at a 4.8% annual rate in the middle two quarters of 2014. In other words, we think the Fed is just hedging its bets.
One subtle change in the statement was removing the sentence from the March statement where the Fed said “an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting.” If the Fed was already convinced a June rate hike won’t happen, they could have just replaced “April” with “June.” But they didn’t, which means the Fed is still set to consider a rate hike at the meeting in seven weeks.
Also notice that the Fed thinks that maintaining the large size of its balance sheet is a form of accommodation, which means slightly higher rates is only one way of making the Fed less loose and the other way of making the Fed less loose won’t happen for some time after it starts lifting rates.
Between now and the Meeting in June, we will get two more reports on the employment situation, two more reports on retail sales, plus lots of other data. If the economy doesn’t rebound then the Fed won’t raise rates in June. If the economy does rebound, as we expect, then we still think a June rate hike is more likely than not.
The Yellen Fed is data dependent and its statement makes it clear the Fed is willing to start raising rates when it is “reasonably confident” the labor market and inflation are heading up. Moreover, we believe the data already say the economy can handle higher rates. Nominal GDP is up 3.6% annualized in the past two years, not much below the 4.4% annual pace of the past 20 years, when the federal funds rate has averaged 2.8%. 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.
Keep in mind, though, if the Fed starts raising rates soon, it’s 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 both Alan Greenspan and Ben Bernanke in the middle of the prior decade. Instead, the Fed will probably raise rates at every other meeting for the first year, before embarking on a more aggressive path in the second half of 2016 and beyond.
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.