(Wednesday afternoon, post-Fed announcement) Once again, the Federal Reserve met expectations on interest rates Wednesday afternoon, leaving the Fed funds rate in a range between 0.25% and 0.5%. But do you hear that tick, tock? The statement tied to the announcement indicates that rate hikes are still firmly on the table this year and the countdown on when they materialize has begun.
The stock market reacted predictably, moving solidly into positive territory after meandering just above the flat line for most of the day before heading into negative territory in the hour before the decision. The S&P 500 (SPX) has nearly totally recovered from its sharp dive in January and February, and was touching two-month highs immediately after the announcement (see figure 1). The dollar dropped slightly after the Fed announcement, while benchmark Treasury yields, which were edging higher ahead of the announcement, lost some momentum.
The Fed’s statement noted that U.S. economic activity has been growing at a “moderate pace despite the global economic and financial developments of recent months.” That’s all good, of course, but the Fed also noted its sensitivity to what’s going on around the rest of the world by adding “global economic and financial developments continue to pose risks.”
To that end, the Fed backed off from its more hawkish expectation to raise rates four times this year to only two hikes. The Fed also cut its long-term rate to 3.3% by 2018, down from 3.5%. The central bank is forecasting a Fed funds rate of 0.9% by the end of the year. For context, back in December, they were forecasting 1.4%.
The Fed Challenges
The Fed is trying to balance two risks: raising rates too quickly, which could undermine the tepid economic recovery; or not raising rates fast enough to prevent inflation from taking off. Inflation, at 1.9% as measured by the Dallas Fed, is at its closest range to the Fed’s target of 2% in two-plus years. At the same time, the 4.9% unemployment gauge in February is near the Fed’s level of full employment. However, data such as retail sales declines in January and February, coupled with lukewarm wage growth underscore a jittery consumer. That’s a thin line and the committee noted that it “seeks to foster maximum employment and price stability.”
Today’s statement puts the market on notice that further rate hikes are on the horizon. The last thing the Fed wants to do is surprise the markets and spring them into another relentless wave of volatility. That said, the markets are not the economy, and the Fed is scrutinizing the economy, but what happens in the markets matters.
Hawks Vs. Doves
There’s clearly a push-and-pull going on at the Fed, which has hawks and doves seeing positive data points in the economy but noting that signs of inflation are “stirring.” While Yellen has repeatedly showed signs of intense sensitivity to economic conditions, wages and unemployment, and consumer spending, the Fed does not want to paint itself into a corner.
Further, Yellen told reporters at a press conference after the statement was announced: “Policy is not on a pre-set course.”
Nine of the committee’s 10 members supported the policy action, but Kansas City governor Esther L. George dissented, preferring an aggressive hike of .50% to .75%.
Has the Fed Lost It?
Economists and stock analysts have heavily debated the Fed’s credibility this week, given its pullback from previous guidance and sensitivity to the markets and global matters. Many believe the Fed should finally push interest rates higher and give more weight to the positive data around the U.S. economy and less to what’s happening abroad. “If they are theoretically data dependent, then the data is indicating that they need to move,” Danielle DiMartino Booth, a former Dallas Fed advisor, said on CNBC ahead of the announcement.
And stop with the transparency already, Fed watchers say. Fed members on both sides of the interest-rate hike spectrum speak frequently about what they are thinking about economic signs as they unfold. That leaves traders with uncertainty—and we know the markets detest ambiguity. “They (Fed members) particularly need to be less transparent between meetings,” David Kelly, chief global strategist at J.P. Morgan funds, said on CNBC ahead of the announcement. “That takes the ability to raise rates out of their hands.”
The CME Group’s FedWatch Tool, calculated based on pricing in the Fed funds futures market, shows traders are now pricing in about a 46% shot for a rate hike in June—down nominally from earlier this week—and a 74% chance for a hike in December, down from 84% earlier today.
Central Banks This Week
JJ Kinahan and Craig Laffman teamed up in a webcast Monday afternoon to discuss key market moves and the potential market impact from upcoming central bank meetings.