Did you expect something different?
There was little drama Wednesday as the Fed did what almost everyone in the markets thought it would and elected to keep the Fed funds rate in a range between 0.25% and 0.5%, right where it's been since last December. In the wake of the Fed's decision, odds for a July rate hike appear to have dropped dramatically, and chances for two hikes in 2016 appear very slim.
In deciding to keep rates unchanged, the Fed cited continued sluggish employment gains, soft business investment and low inflation, it said in its statement.
"The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation," the Fed said, noting that improvements in the labor market have slowed, job gains have diminished and inflation remains below its 2% target.
Looking forward, the Fed didn't forecast when it might hike rates, but stuck to language that's beginning to sound familiar, using the word "gradual" to describe the pace of future increases and promising that data would continue to drive decisions on rates.
"In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal," the Fed said. "The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data."
The Fed's statement painted a mixed economic picture, pointing to the weaknesses mentioned above but also to a pick-up in economic activity, growth in household spending and improvement in the housing sector. Basically, the Fed is walking a tightrope, but the ultimate message is pretty dovish.
Looking farther out, the Fed now sees rates at 0.9% in 2016, 1.6% in 2017 and 2.4% in 2018. All of those projections are below where they were previously.
In the wake of the Fed's decision, stocks initially held onto the day's light gains. The U.S. dollar extended its losses, and gold futures traded around unchanged levels. The odds for a July rate hike now stand at 12%, down from about 25% earlier this week, according to Fed funds futures traded at the Chicago Mercantile Exchange. Odds for a September hike are now at 28% and odds for a December hike are right at 50%.
Last December, the Fed raised rates first time since 2006, and at the time analysts expected at least a couple more hikes in 2016. That's starting to look less and less likely as the calendar year nears its halfway point and the U.S. and global economy keep sending signals of weakness. The yield on U.S. 10-year Treasury bonds fell to 1.6% early Wednesday.
There were no dissenters in the Fed's vote today, and six Fed officials now see just one rate hike occurring in 2016. The last time the Fed voted not to raise rates, earlier this year, there was just one official who saw chances for only one rate hike.
In her press conference following the statement, Yellen again emphasized that the Fed would make gradual rate increases, citing what she called mixed economic data. She did add that the U.S. economy seems to be rebounding in the current quarter.
Figure 1: Standing Pat: The S&P 500 (SPX), plotted here through midday Wednesday on the TD Ameritrade thinkorswim® platform, initially held onto its earlier gains after the Fed left rates unchanged. Source: Standard & Poor's. For illustrative purposes only. Past performance does not guarantee future results.
Fed Concerned About Labor Market: In April, a number of Fed governors made speeches strongly supporting a near-term rate hike, and then in late May Fed Chair Yellen upped the ante, saying in a speech at Harvard that "it's appropriate for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in coming months such a move would be appropriate." Yellen pointed to an improving labor market and other positive economic indications, and it appeared a solid bet that the Fed would come through with at least two rate raises this year as the market had expected. But the May employment report showing just 38,000 jobs created came right after Yellen's speech. And judging from the Fed's statement Wednesday, that report carried a lot of weight. By the time of the next meeting, in late July, the Fed should have had a chance to digest the June job report, which comes out in early July. That data could help shed light on whether the May report was an outlier or part of a gathering trend toward economic weakness.
Election Another Wrinkle in Fed's Plans: The Fed may face another challenge if it decides to hike rates later in the summer or fall: The U.S. Presidential election will be fast approaching, and is already contributing to some of the market's recent volatility, analysts say. This year's election, with sharp divides among the two leading candidates, certainly seems likely to escalate nerves between now and November, not necessarily the best environment for a rate hike. Asked recently if the election could further complicate the Fed's plans, Yellen replied, "I'm sorry. I've got nothing for you on that. We're very focused on doing our jobs, and we'll see what happens," media reported. There is historic precedent for the Fed to raise rates during the heart of an election season, most recently in 2004. And that election year didn't lack for drama, though it may not approach what's going on this year.
No Press Conference? No Problem: Lack of a scheduled press conference at the July meeting is one reason some analysts discount the possibility of a rate hike at that point. But it's far from out of the question. The Fed can hike rates whenever it wants, even between meetings. Or it could add a press conference to the July meeting. The Fed probably wanted to avoid raising rates today in part due to the coming British "Brexit" vote next week on whether to stay in the European Union. Later this year, the Fed might want to avoid injecting additional volatility by raising rates in the teeth of an election season. But whether or not there's a press conference in July, it appears odds for a hike then are very slim, or at least the futures market sees things that way.
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