The Fed meets: Our thoughts

March 14, 2017

With the FOMC, the Federal Reserve’s monetary policymaking body, meeting today and tomorrow, it’s timely to preview the potential outcomes. 

This FOMC meeting will be closely followed given the potential for a change in interest rates. In addition, Janet Yellen will hold a press conference after the meeting and the committee will publish updated economic projections. The latest data point from the nonfarm payroll report, combined with guidance from recent speeches by key Federal Reserve policymakers, has largely cemented a 25-basis point rate hike on Wednesday. Additionally, given the proximity to achieving the Federal Reserve’s dual mandate, there is an upward bias to the projection for the number of rate hikes in 2017. At this meeting the committee may raise their forecast to four rate hikes this year from the previous guidance of three. Continued solid economic growth could also result in the Federal Reserve beginning to shrink its $4.5 trillion balance sheet later this year.

After passing the eight-year anniversary of the economic recovery last week, the slow but steady expansion is now the third longest on record. Despite its long duration, the expansion remains well entrenched. For example, last Friday’s nonfarm payroll report was strong; 235,000 new jobs were added during the month of February while unemployment ticked down from 4.8% to 4.7%. Average hourly earnings also increased 2.8% year over year, a modest improvement over an upwardly revised January rate of 2.6%.

The addition of 235,000 new jobs in February compares favorably to last year’s average monthly gain of 187,000. While the expansion is firmly intact, unseasonably warm weather helped to boost job growth last month. February 2017 was the second warmest February on record for the lower 48 and helped to accelerate construction activity which pulled forward 58,000 new jobs from future months. Despite the boost from warmer weather, many other economic data points confirm that the expansion is intact and there is a significant chance for growth to accelerate from current levels. 

At this juncture, it appears that the Federal Reserve may have the confidence to raise interest rates between three and four times this year. The Federal Reserve’s dual mandate requires an emphasis on price stability and maximizing employment, both of which have largely been achieved. The unemployment rate of 4.7% is close to the 4.4% rate posted during the halcyon days of late 2006. Headline PCE inflation of 1.9% is also close to the Federal Reserve’s target of 2.0% and is the highest in over four years. These factors, combined with affirming economic data points, raise the probability that we will see an increase in the pace of rate hikes this year.    

While the pace of hikes is expected to quicken in 2017, we continue to believe that the Federal Reserve will remain data dependent and that secular issues, such as high government debt levels, will continue to act as a headwind. Growth rates may increase, but not to such a degree that the Federal Reserve is forced to rapidly raise interest rates at a single meeting. Instead, we expect a gradual progression of higher rates as economic growth improves.

For a closer look at these topics, please see our February blog post.