Economic Update

June Fed Meeting

The outcome of last week’s FOMC meeting went as expected with the Fed leaving its statement mostly unchanged and the Fed Funds rate near zero. They upgraded their assessment of the economy from “growth slowed during the winter months, in part representing transitory factors” to “activity has been expanding moderately after having changed little during first quarter”. The Fed also released its Summary of Economic Projections (SEP) which includes forecasts for inflation, employment and GDP growth. Expectations for inflation and employment were unchanged, but the GDP growth forecast was reduced to account for the weakness of the 1st half of the year. And in its table used to guide Fed followers about its expected path for the pace of policy tightening, known as the Dot Plot, the pace of policy tightening was revised slightly lower.

Once again the Fed has been required to lower its forecast for the inevitable “liftoff” for rates even though most of the economic news released the past month or so has been improving. There’s an active debate among central bankers how much of that weakness owed to the terrible winter weather seen over much of the nation, and how much might be due to deeper issues in the economy. The Fed’s rate forecast is dependent on their economic forecast which could be described as optimistic the past six years. And the 1st half of 2015 on balance has been below expectations coming into the year. So when will the Fed raise rates? September? December? Both? Or next year?

During the press conference after the Fed meeting Ms. Yellen was asked what sort of economic data would suggest it’s time to raise rates, Ms. Yellen declined to get specific:

“It would be wrong for me to provide you a road map that was as simple as ‘if the unemployment rate declines to x,’” Ms. Yellen said. A range of factors must be considered, she said, from the pace of job creation, the labor force participation rate, part-time employment for economic reasons, job openings, the pace of quits, wage inflation and other indicators to the state of the labor market.

“My colleagues and I would like to see more decisive evidence that a moderate pace of economic growth can be sustained.”

The Fed has been burned many times in this expansion by growth forecasts that didn’t hold up. Ms. Yellen has little inclination to move until she sees strong evidence in the data that it can be justified.

Ms. Yellen also emphasized that perhaps the exact “liftoff” date is not as important as the speed and duration of subsequent rate hikes. And the rate hike path of the future was again revised lower. The median forecast for the Fed Funds target rate by YE2016 was reduced from 1.875% to 1.625% while the forecast for YE2017 was revised lower from 3.125% to 2.875%. This in and of itself is not particular news, except that it continues a pattern over this entire recovery. It’s the cumulative effect leading the Fed to express and Fed watchers to anticipate a much slower path of tightening over the next cycle.

Again from the press conference her message is that increases will be gradual and shallow. The commitment to a gradual path didn’t show up in the Fed’s formal policy statement, but Ms. Yellen said the public can effectively interpret the Fed’s policy statement to be saying as much.

“The last paragraph of the Federal Open Market Committee statement says the committee currently anticipates that even after employment and inflation are near mandate consistent levels, economic conditions may for some time warrant keeping the target federal funds rate below levels the committee views as normal in the longer run. That’s kind of a mouth full. It is a long sentence. But I think the spirit of that sentence is consistent with my use of the word gradual.”

“I think we need to see additional strength in the labor market and the economy moving somewhat closer to capacity–the output gap shrinking–in order to have confidence that inflation will move back up to 2%.”

Six years after the recession ended, the Federal Reserve is weighing whether the economy can finally withstand higher interest rates. I will reiterate that the latest data continue to point to an economy barely above stall speed and the Fed has no intention of prematurely creating a stall. They recognize that in spite of their desire to raise rates, the economy must be able to absorb them. The Fed may begin to raise rates this year but aggressive policy moves are still far, far away.