In its policy statement, the Fed subtly upgraded its outlook for inflation and said conditions would warrant “further” interest rate increases, suggesting to us that a policy rate hike at the March meeting is all but a foregone conclusion.
Despite No Marked Shift in Policy, We Still Find Interpretive Value in Today’s Fed Statement
The Federal Reserve Federal Open Market Committee policy statement, the last drafted under Chair Yellen’s leadership, was not significant in terms of signifying any meaningful change in policy expectation, but there are short-, medium- and longer-term implications that can be drawn from it.
Indeed, to begin with, the announcement served to upgrade the Fed’s perception and interpretation of the current rate of inflation. While inflation remains moderate today, it is trending higher and the Fed changed their outlook today to say explicitly that inflation is expected to move up this year. The statement also says explicitly that economic conditions will warrant “further” gradual increases in the federal funds rate. And while this merely entails a subtle shift in interpretation by the Fed, it very clearly suggests a desire by the Committee to move policy rates another 25 basis points higher at the March meeting, in our view.
The Fed, while now interpreting the rate of inflation to be closer to a level approximating its target, shouldn’t and won’t feel any rush to move rates significantly faster than indicated by the last reading of the Summary of Economic Projections dot plot. That is partly because while inflation is accelerating, it is doing so at a moderate pace, as displayed by one of the Fed’s preferred inflation readings, Core Personal Consumption Expenditures, which only registered 1.52% at last measure. The Fed will closely watch the full range of inflation measures and the central bank will be in no rush to move policy normalization faster than previously outlined. To be clear, this suggests three policy rate hikes in 2018, but we still think there’s the potential to move a fourth time this year.
Another point to consider is that it is possible, with growth currently running hotter than we’ve seen in many years, the terminal rate of the Fed’s policy path this cycle could be higher than we might have previously expected. In fact, it’s possible to imagine terminal policy rate levels into the low- to mid- 3%-range, which suggests that interest rates longer than two years, or so, could be subject to unexpectedly higher rate-levels than presently priced into markets. So as we think about the Fed’s policy rate adjustments, and its pace/destination, we think that the destination may be higher than some currently believe, with the pace fairly consistent with what we saw in 2017.
Finally, it’s important to note that the Fed statement also marks a transition in Fed chairpersons, from Chair Yellen, who very capably led the institution, to Chair Powell, who we hold equally high opinion of. Ultimately, we don’t think that there will be a major change in how the current or future economic data, or environment for interest rates, is assessed by the FOMC under the new Chair, but there are still seats to be filled on the Fed board. Those new personalities and backgrounds will unquestionably be different than the previous FOMC, so watching for future announcements, such as who the Vice Chair will be, may provide significant clues as to how the future Fed will operate. That in turn will help us better understand how to build an accounting of Committee membership changes into our Fed-influenced interest rate calculus.
Rick Rieder - Chief Investment Officer of Global Fixed Income - BlackRock