 | Fed Talks Hawkish, Acts Dovish |
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| Posted Under: Government • Research Reports • Fed Reserve • Interest Rates |
Three major takeaways from today's statement and projections from the Federal Reserve:
First, the Fed upgraded its assessment of the current state of the economy, lifting its general appraisal of the labor market, housing and consumer spending.
Second, the Fed downgraded its assessment of real GDP growth in 2015, to about 1.9% from a prior estimate in March of about 2.5%. We think this is an overreaction to weakness in Q1, which was due a combination of temporary factors (bad weather, port strikes, and oil price declines) as well as the government's poor job of seasonally-adjusting the data. The same thing happened last year, when the economy contracted in Q1, the Fed downgraded its forecast in June and then the economy ended up beating that forecast.
Third, consistent with the downgrade of projected economic growth in 2015, the Fed's "dot matrix" showing where policymakers think interest rates will go over the next few years shows a shallower glide path for rate hikes. Back in March, the dots showed the median policymaker at the Fed thought short-term rates would rise 50 basis points this year and 125 bp in 2016. Now the median dots suggest 50 bp this year but only 100 next year.
All of this adds up to the likelihood that the Fed will start hiking short-term rates in September, although a rate hike in either late July (the very next meeting) or even October shouldn't be casually dismissed.
Why September? One reason is that the Fed's dot matrix strongly hints at two rate hikes this year and then a pattern of moving every other meeting in 2016. That would be consistent with raising in September and December this year, while taking a breather in October/November which would give Fed Chief Janet Yellen the chance to explain the rate hikes at a regularly scheduled press conference.
Another reason is that the September meeting will be the first time the Fed will have the government's annually revised figures on real GDP growth for the first quarter plus the initial glimpse of growth in Q2, which should be much better than Q1, just like last year. Given our forecast of much better news in that report, it's hard to see the Fed waiting beyond September to start raising rates.
We believe the Fed should have raised rates today; the economy can handle it. Nominal GDP - real GDP growth plus inflation - has grown at a 3.5% to 4% annual rate for the past five years. That suggests a "neutral" monetary policy, one consistent with a stable general price level, would put the federal funds rate somewhere north of 3%.
Some analysts say monetary policy shouldn't be neutral right now, that it should still be expansionary, because the economy hasn't fully recovered from the last recession. But the unemployment rate is now 5.5%, with job openings (demand for labor) at a 15-year high and tepid growth in labor supply. Moreover, even a 1% federal funds rate would leave monetary policy expansionary.
Meanwhile, the CPI ex-energy is up 1.8% in the past twelve months and energy prices are more likely to be up in the next twelve months rather than down. In other words, we may get to the 2% inflation target much faster than the Fed now anticipates.
Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist
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