FOMC members deemed economic activity “expanding moderately” with various sectors seeing some activity. The language, though, was tempered and the various indicators the Fed uses to tip its hand on policy showed little movement. Economic estimates from Fed officials showed a considerably lower expectation for growth this year.
Market participants were looking toward the rest of the committee’s report, which included economic projections and the so-called dot plot that diagrams individual members’ expectations for the future path of rate hikes. The graph showed a wide swath of views, with little consensus other than a rate hike is likely at some point this year.
“There is consensus emerging that something should happen this year. That will certainly focus all of our attention on September. The debate is not whether do to something, but rather how much,” said Carl Tannenbaum, chief economist for Northern Trust. “The news today offers quite a lot to think about.”
Traders initially took the remarks in a dovish sense, with the Dow industrials turning mildly positive after being down 25 points or so prior to the release. Bond yields edged lower, with the 10-year Treasury note trading around 2.35 percent.
Parsing through the projections and the dot plot showed a Fed not ready to hike yet, but ready to pull the trigger over the next couple of years.
The Fed wants to “keep rates lower for longer, but when it comes time to hike, hike faster. Keep rates low, but allow inflation pressures to build. Before they get out of hand, hike rates faster to stop any inflation,” said Jim Caron, portfolio manager with global fixed income at Morgan Stanley Investment Management. “What’s really interesting is we’re really just moving to optimal control on the path of Fed funds, which is lower for longer but when you hike you hike a little faster.”
The Fed probably will hike in September and again in December, said Phil Orlando, chief equity strategist and portfolio manager at Federated Investors.
“A lot of investors are. Certainly the bond market is” expecting a rate hike, Orlando said. “That’w one of the reasons we saw ‘taper tantrum’ 2.0 over the last month or two…That was the realization that the economic data was getting sufficiently strong that the Fed was going to give serious thought to September.”
The FOMC move comes as unemployment continues to drop but inflation shows almost no signs of getting to the Fed’s target rate of 2 percent. The jobless rate has fallen to 5.5 percent but most inflation measures are moored in the 1 percent to 2 percent range, with low wage pressures, energy prices well below their year-ago levels and the gross domestic product in check.
Traders for months had been expecting the Fed to move at the June meeting. Now, the likelihood is for September at the earliest, with Chicago Mercantile Exchange trading indicating a higher probability in December.
The economy thus far has fallen well short of 3 percent growth expectations. GDP actually contracted 0.7 percent in the first quarter and, according to the Atlanta Fed, is likely to rise only about 1.9 percent in the second quarter.
That’s created a dilemma for the Fed, which would like to normalize policy but fears disrupting a still-fragile recovery.
Economic estimates from Fed officials turned more pessimistic in the short term and a shade more optimistic in the longer term than the last estimates in March. GDP in 2015 is expected to fall in the 1.8 percent to 2.0 percent range, down from 2.3 percent to 2.7 percent.
Inflation expectations were little changed, with growth still expected to fall in the 0.6 percent to 0.8 percent range for 2015.