The Fed raised its benchmark interest rate Wednesday as expected, and included more hawkish language in a statement indicating a stronger economic outlook.
In its seventh rate hike since December 2015, the central bank raised the federal funds rate a quarter percentage point to a range of 1.75 percent to 2 percent. That’s the highest level since 2008, and apparently indicates that the Fed believes the U.S. economy is strong enough to warrant such a hike in an attempt to manage inflation. Recall that in its previous post-meeting statement, the Fed pointed out that inflation was finally near its objective of 2 percent, and also that it might let inflation run a little higher than that for a while.
With the hike already priced into the market, investors were likely keen to hear what policy makers thought of recent price and wage data and what the numbers could portend for the central bank’s next move.
Although the central bank kept the word “accommodative” to describe its monetary policy, its statement accompanying the rate hike was more hawkish. For example, it replaced an instance of talking about rate changes as “adjustments” in favor of the word “increases” and added a phrase on “sustained expansion of economic activity.”
It also dropped a phrase about keeping rates low to boost the economy “for some time.”
Policy makers were more upbeat in their economic outlook. They indicated that they upgraded their assessment of economic growth from “moderate” to “rising at a solid rate.”
On another note, in his post-decision press conference Fed Chair Jerome Powell said starting in January the Fed will hold press conferences after every one of its eight annual meetings instead of just quarterly. This is designed to give the Fed “more opportunities to explain our actions and take your questions,” Powell said, adding that the decision “doesn’t signal anything” about the timing or pace of future rate changes.
In his remarks, Powell struck an upbeat tone about the economy. “The main takeaway is the economy is doing very well,” he said at the start of the press conference. Inflation, he added, is moving closer to the Fed’s 2 percent objective, but “it’s too early to declare victory.” He noted that inflation could be a bit above 2 percent in coming months due to high energy prices, but doesn’t see a long-term impact from that.
Trying to Strike a Balance Amid Crosscurrents
The Fed marched into this meeting facing some critical questions. Notably, is it ready to push U.S. rates much higher over the next few months even as central banks in Europe and Japan seem to be remaining accommodative as the gap between rates in Europe and the U.S. widens? There’s a sense that Powell and company might not want to let that spread between U.S. and European rates get too out of whack for fear of potentially upsetting the trade balance.
Another question the Fed faces is the pace of future wage gains, which could have a big impact on inflation. The 2.7 percent year-over-year growth in May hourly pay the government reported earlier this month doesn’t necessarily raise big inflation worries, but the 3.8 percent unemployment rate—a two-decade low—has some analysts saying that they are wondering if employers might have to start raising wages more aggressively to attract new workers. The Wall Street Journal reported Tuesday there are now more job openings than there are people looking for jobs for the first time since that kind of record keeping began in 2000.
During his press conference, Powell addressed the question of how much higher the Fed might raise rates if it wants to get them back to a neutral level where they’re not too stimulative or start to compress economic growth. Basically, he said that the Fed will just have to continue watching the data come in. He didn’t say where a neutral rate might be.
The updated Fed “dot plot” looking at individual Fed members’ projections for rates over the next few years showed eight Fed policy makers expected four or more quarter-point rate increases for the full year, compared with seven officials during the previous forecast round in March. The number viewing three or fewer hikes as appropriate fell to seven from eight. The median estimate implied three increases in 2019.
From an inflation standpoint, Powell said the Fed sees prices rising at a median of 2.1 percent through 2020 and sees unemployment at 3.5 percent over the next two years. Predictions are only predictions, but if the Fed is right, numbers like that might be welcomed by many stock market investors.
Tariffs Could Be Ticklish Issue for Fed to Tackle
In addition, the Fed has to consider the possibility that deteriorating trade relations between the U.S. and trading partners China, Europe, Mexico, and Canada might start causing blowback. Former Fed Chairman Alan Greenspan, appearing on CNBC Wednesday morning, said tariffs imposed by the administration have the potential to raise prices for U.S. consumers and cause job losses for U.S. workers. If that happens, it could slow economic growth. Notably, the Fed didn’t mention trade in its shorter-than-usual statement Wednesday afternoon.
Prior to the announcement and press conference chances for a hike by September stood at around 71 percent while chances for a fourth hike by the end of the year were around 45 percent. While the odds for a hike by September stayed about the same after the Fed announced its decision Wednesday, chances for a fourth hike climbed above 50 percent shortly after the news.
With a fourth rate hike now looking more likely, it could raise peoples’ inflation radars and possibly drag on the stock market. The other way to see it, however, is as a sign of solid economic growth and possible positive for stocks. Prior to the Fed announcement, the S&P 500 (SPX) and Dow Jones Industrial Average ($DJI) were little changed while the Nasdaq (COMP) was up around 0.4 percent and hit a record. The benchmark 10-year Treasury yield had been hovering around 2.97 percent. After the Fed move, however, the $DJI and SPX dipped a little and the 10-year yield rose to 2.98 percent. A hawkish Fed like the one we’re seeing today can sometimes mean less traction for stock market rallies, but higher rates can also help financial stocks. The financials rallied in the wake of the Fed news Wednesday.
Figure 1: Separate Ways: In the minutes after the Fed raised rates Wednesday, the S&P 500 (candlestick) took a slight dip, while yields on the 10-year Treasury (purple line) jumped but remained below the psychological 3 percent mark. Data source: S&P Dow Jones Indices, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
Other Central Bank Action in Focus
With the widely anticipated Fed rate hike out of the way, investors may turn their focus to two other central bank meetings this week. The European Central Bank (ECB) is scheduled to hold a press conference Thursday after a two-day meeting in Latvia, and the market could learn whether the ECB will end its bond purchases when the $35 billion a month program expires after September. Such a move might lift the euro and weigh on the U.S. dollar, potentially a boon for U.S. companies selling into the eurozone. Meanwhile, the Bank of Japan (BOJ) meeting concludes Friday with a policy statement. The Asian nation could continue its easy money policy as inflation numbers in Japan continue to lag the BOJ’s targets. That probably wouldn’t have much effect on the yen, one of the world’s safe-haven currencies.
Recent Inflation Data
Based on inflation data from this week it looks like the economy is continuing to grow at a steady clip, but not too fast as to raise worries about inflation. Core producer price index data came in at 0.3 percent, slightly higher than the Briefing.com consensus expectation of 0.2 percent. That’s on the heels of a core consumer price index number that registered a 0.2 percent gain, in line with economists’ expectations. While these numbers are encouraging from a growth standpoint, they don’t offer many clues as to whether there will be a fourth rate hike this year. Numbers well under expectations might point to that not happening, while very high figures could give the Fed more ammo for such a hike. For now, it looks like this porridge is not too hot and not too cold. A concern though is a 0.5 percent overall PPI growth number for May. It’s just one month, but something to keep an eye on.
Beyond Monetary Policy
After the market digests news from the Fed and other central banks this week, investors may turn their focus back to geopolitics and corporate news. The trade spat between the U.S. and key trading partners could take center stage. And the market might continue watching for progress on talks between the U.S. and North Korea about denuclearizing the Korean Peninsula. In the absence of corporate earnings news, these headlines could move the market up or down.
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