The Fed Revises Forecast, Signals Two Rate Hikes

The Federal Reserve reconvened March 15 and 16, and again took a pass on raising interest rates, signaling instead that it plans to raise rates only twice in 2016, not four times as initially expected. Baird sat down with Senior Fixed Income Analyst Craig Elder, author of “Fixed Income Weekly,” for his perspective on the meeting. 

Baird: Craig, what did you find most interesting about the Fed’s March meeting?

Craig: The tone of this meeting was more dovish. While we’ve been predicting two rate hikes for quite some time, today Fed officials confirmed that the pace of rate hikes will be slower than originally planned. They put back in their statement that global economic and financial developments of recent months have given them cause to adjust course. It’s worth noting that it was not a unanimous vote this time. Kansas City Fed President Esther George voted no, citing she was in favor of raising rates at this meeting.

Baird: How have the markets responded to the Fed’s decision not to raise rates?

Craig: Overall Treasury prices are higher, with the yield on the 10-year Treasury note down about 5 basis points. I would expect market volatility to continue, but I think it would take a major outlier event to move the markets significantly over the next couple weeks, which are typically quieter due to the Easter holiday.

Baird: How concerned is the Fed about inflation? 

Craig: The Fed did note that inflation has picked up in recent month, but it’s still below their target of 2%. The core PCE (personal consumption expenditures excluding food and energy prices) number, which they will be monitoring closely, is close to 1.7% now.

Overall, they don’t seem to be too concerned about wage inflation specifically because the average hourly earnings number last month was down. However, my thinking is that if the unemployment rate continues to trend down, you’re going to get some wage inflation. That could become a concern as it would ultimately drive inflation higher.

With that said, even if overall inflation goes above 2%, I think the Fed will still take a “measured” approach in raising rates. I do not believe that hitting a 2% inflation target will force their hand.

Baird: At this point, what are you expecting in terms of future rate hikes this year? 

Craig: I’m still calling for two rate hikes. It’s possible there might only be one, but I do think June is on the table. I think the Fed will raise rates another 0.25% at the June meeting and then again in December, as it did last year. I think a September rate hike is less likely given the impending presidential election.

Baird: What will Fed officials be watching as they consider when to raise rates next?

Craig: The Fed will be looking at what’s happening, such as the European Central Bank’s recent decision to expand its stimulus program. Additionally, they’ll be monitoring inflation, with an eye toward the core PCE and employment numbers specifically. It’s very difficult because we are in a period of slow economic growth. Hopefully we get to GDP growth in at least the 2.2% to 2.3% range this year. Ideally what the Fed would like to see is 3.5% to 4% GDP growth overall.

Baird: The Fed has changed course a few times now. Could this waffling damage the Federal Open Market Committee’s (FOMC) credibility? 

Craig: There has been some criticism that the Fed is saying one thing and doing another. It’s our view that the FOMC is in a tough position. Inflation has increased recently, but economic growth remains tepid. Additionally, growth in China is slowing, while Japan and Europe have little or no growth, and the Fed needs to take the global economy into consideration. We believe that’s why they need to be data driven and stay flexible.