The Fed: More Rate-Hike Clues

June 18, 2014 5:15 PM
By Zane Brown

The central bank’s more upbeat assessment of the economy and the labor market, along with new interest-rate projections, reinforces expectations of a fed funds hike in 2015.

With the Federal Reserve’s tapering effort firmly on track, investors focused on the June 17-18th meeting of its policy-setting arm, the Federal Open Market Committee (FOMC), for any hints as to potential interest-rate hikes in 2015. Investors didn’t get the “smoking gun” they were looking for—that is, a definitive indication as to the timing and size of a rate hike—but they got some information on the Fed’s view of key inputs into such a decision.

In its post-meeting statement, the FOMC noted that given the current level of policy accommodation, it expects that "economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually," adding that "it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends."

The improvement in the economy and labor markets, although neither yet at an accelerated pace, along with recent data showing inflation in the neighborhood of  the Fed’s 2% target, could put policymakers closer to a decision to hike the fed funds rate, from its current range of 0–0.25%, where it has been since December 2008.

Investor speculation on a move in the fed funds rate was fueled by several factors. On June 17, for example, Bank of England governor Mark Carney said he "would not hesitate" to take action to prevent Britain’s economy from accelerating too quickly, according to a Reuters report, raising expectations of a rate hike by the central bank. In the United States, a report from the Bureau of Labor Statistics on June 17 revealed a larger-than-expected increase in the Consumer Price Index (CPI) in May, with the headline 12-month CPI figure of 2.1% slightly above the Fed’s inflation target.

Meanwhile, on June 18, the Fed also released forecasts for the economy and interest rates over the next few years. Most notably, Fed officials tweaked higher their forecast for interest rates at the end of 2015, to 1.25% from the 1% estimate in March. The so-called "dot plot" chart, which measures FOMC participants'  judgment of the appropriate level of the target fed funds rate at the end of a specified calendar year, or over the longer run, also pushed up slightly the pace of rate hikes in 2016, from 2.25% to 2.5%. At the same time, the Fed lowered its forecast for “longer run” interest rates to 3.75% from closer to 4%. 


Chart 1. The "Dot Plot" Thickens for Interest Rates
FOMC participants’ assessment of appropriate fed funds rate, 2014-onward

Source: Federal Reserve. Each shaded circle indicates the value, rounded to the nearest one-quarter percentage point, of an individual participant’s view.


What does this mean for interest rates? Essentially, the Fed expects to pursue faster hikes in the fed funds rate toward a lower long-term target.

As expected, the FOMC voted on June 18 to again reduce its quantitative easing (QE) program by $10 billion per month, from $45 billion to $35 billion ($20 billion in Treasury securities and $15 billion in mortgage-related securities). This pace of tapering puts the Fed on track to wind down QE by the October policy meeting.

The next FOMC meeting is scheduled for July 29–30. By then, additional data reports should signal whether inflation is solidly at or above the Fed’s target, which may give policymakers another reason to hasten rate hikes.

Zane Brown is a Lord Abbett Partner and Fixed Income Strategist.

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