The Fed Continues on Path Toward Normalization

January 29, 2016

The Federal Reserve reconvened Jan. 26-27 for the first time since it raised interest rates by 0.25%. Baird sat down with Senior Fixed Income Analyst Craig Elder, author of "Fixed Income Weekly," for his perspective on the Fed’s first meeting of the year.

Baird:
Craig, what were your key takeaways from the Fed’s January meeting?

Craig:
The Fed didn’t back off or say anything about market or global conditions causing them to pull back. Officials have indicated they will carefully monitor actual and expected progress toward their inflation goal when considering future interest rate hikes.

Baird:
What are you expecting in terms of future rate hikes this year?

Craig:
Truthfully there’s a wide range of opinions here. Fed fund futures indicate there will be one interest rate move this year in September, while the economists are leaning toward three moves. Ideally I think the Fed moving twice would probably be the best situation – once in March and then not again until December after the election. I can’t see four rate hikes this year.

Baird:
What is the Fed’s primary concern as they consider future rate hikes?

Craig:
The Fed thinks inflation is going to pick up – not this year, but maybe next – and will progress toward their target of 2%. They don’t want to be behind the curve when that happens.

At this point, a lot of the inflation numbers look good, because energy prices are down. If you were to move back to $40 to $45 a barrel for oil, your inflation numbers will start looking considerably different. Meanwhile, we’re still at 5% on the unemployment rate, and we’re running under 300,000 initial jobless claims per week. That means the job market is still fairly tight especially for skilled workers. 

Baird:
Is the volatility we’ve been seeing in the equity markets a factor the Fed will consider as they look to their March meeting? Do you think they’re second guessing their decision to raise rates in December?

Craig:
It’s not yet clear how much attention Fed officials are paying to the markets. The makeup of the Federal Open Marketing Committee has changed with the addition of three new voters and the group as a whole is now more hawkish.

I do think officials are committed to this path toward normalization and feel the decision they made to increase rates very modestly at their last meeting was the right one. Current market volatility has much more to low energy prices and what’s happening in China, than anything the Fed did. We would have to go into a recession for the Fed to reverse course at this point.