Here is what we know, with a degree of certainty, as of now with respect to future Federal Reserve ("Fed") activities:
- Fed Chair Janet Yellen said her expectation for the first increase in the Federal Funds Target Rate would come approximately six months following the end of the asset purchase program - through the infamous "tapering process".
- The median rate forecast of Fed policymakers for the end of 2016 currently is 2.25% (which may ultimately prove to be too aggressive), raised from 1.75% back in December 2013.
We also contend that:
- The Fed will continue on its current pace of a $10 billion reduction of its bond purchase program following the completion of each of its scheduled FOMC meetings in 2014. This should bring the tapering process to a close in the fall of this year.
- When it does begin to raise interest rates in 2015, the Fed will likely follow its blueprint that it utilized during the 2004-2006 tightening period when it gradually raised the Federal Funds Target Rate on 17 different occasions in 25 Basis Point (0. 25%) increments over this timeframe. This gradual, drawn-out tightening is appropriate, in our view, given the Goldilocks state of the U.S. economy which is not "too hot" to warrant a shorter tightening timeframe or larger increments of increases and not "too cold" where the Fed would consider additional stimulus measures (including, but not limited to, maintaining current record low interest rate levels for an even further extended period of time).
As a result of what we know, based upon what the Fed has communicated, and what we contend, based upon current economic data reports and forecasts, here is our current projected Fed activity timeline through the end of 2016. Please note: 2016 FOMC meeting dates are estimates based upon recent history and not confirmed.
All of this depends upon the economy continuing to show signs of consistent growth in the months ahead to allow the Fed to feel comfortable beginning their closely monitored tightening process. To this end, the International Monetary Fund ("IMF") recently cut its Gross Domestic Product ("GDP") growth estimate for the U.S. to 2% for 2014, down from the 2.8% that it has forecast for the year as recently as April.
While the IMF is still forecasting 3% annualized GDP growth in 2015, it also forecasts weaker potential growth of "around 2%" for the next several years due to the effects of population aging and more modest prospects for productivity growth according to MarketWatch.com. These forecasts coincide with our earlier mentioned Goldilocks analogy though if growth hovers "around 2%" for too long or dips below 2% this would then fall into the "too cold" camp and may require the Fed to alter its tightening activity timeline.