U.S. Commentary: Fed keeps rates unchanged for the time being, but sets up a December rate hike
- As broadly expected, the Federal Open Market Committee (FOMC) left the target range for the federal funds rate unchanged at between 1/4 and 1/2 percent. Having said that, the Committee judged that the case for a rate hike has strengthened, but will wait "for the time being" for this view to be more evident in the data.
- The Committee believes that economic growth has accelerated from the "modest pace seen in the first half of this year," despite business investment remaining soft. The labor market was believed to have continued to strengthen as job gains have come in "solid, on average."
- The Committee now views the near-term risks as roughly balanced, but will monitor global economic and financial developments closely.
- The Fed remains optimistic as far as the economic outlook and expects the labor market to strengthen "somewhat further" and inflation to track higher as transitory factors dissipate.
- In the attached summary of economic projections (SEP), Fed officials downgraded their outlook for GDP this year and over the longer run (by 0.2pp) to 1.8%. They also toned down slightly (0.1pp) their expectations for PCE headline inflation this year, and core PCE inflation next year. Unemployment was also seen as remaining slightly higher this year at 4.8% (prev. 4.7%) but is expected to trough at a lower level of 4.5% (vs. 4.6% before) in 2018.
- Interest rates projections in the SEP were lowered, with the median expectations for this year 25bp lower at 0.625 and 50bp lower in the following two years at 1.13% and 1.88%, respectively. Long-term expectations were also generally lower, with eight members believing the natural rate of interest is below 3% and six believing it was at 3%. Only two members viewed the natural rate as being above 3%.
- Esther George (K.C.) was joined by Loretta Mester (Cleveland) and Eric Rosengren (Boston) in dissenting, with all three preferring to raise rates by ½ percent this time around.
- The Fed did not disappoint markets and kept the benchmark rates unchanged this time around. However, it would appear that the views of the Committee members are quite sanguine, with most of the downgrades to the economic outlook viewed as in the rear-view at this point. Importantly, the Fed views economic momentum to have accelerated from the first-half slowdown despite still weak business investment, with moderate growth expected for the remainder of the forecast horizon on the back of solid fundamentals in domestic demand.
- In addition to the largely unchanged outlook, the Committee now also views the risks as balanced. This, alongside the view that the labor market has only "somewhat further" to strengthen, is indicative that most members feel that the we're nearing the level of full-employment. As such, we expect the Committee to pull the trigger on rates later this year, assuming that global markets don't convulse and U.S. data cooperates, with inflation metrics particularly in focus.
- Ultimately, we view this statement as a set-up for a hike later this year. At this point, the Fed feels the case for a hike has strengthened and is merely waiting "for the time being" out of prudence to ensure that their outlook is corroborated by the incoming data. Taken together with the three hawkish dissents – something itself very rare – we believe that the Fed is running out of room to keep rates unchanged given the economic performance. Having said that, it would appear that the pace of future hikes will be much slower and the ultimate ceiling for rates lower than previously thought. We believe this is the correct approach, raising "earlier but slower" rather than "later and faster".
Michael Dolega, Senior Economist
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