The Federal Open Market Committee didn’t raise rates – no surprise here – in the September meeting and left the door open for a possible rate hike later this year. Now all bets are set for a December hike; and currently the odds of a hike by then are around 60%. But the FOMC decided not to raise rates even though the statement clearly stated the economic conditions allow for a rate hike. And this comes on the back of another cut in the neutral cash rate to 2.875% — back in June the rate was set at 3%.
Source: Federal Reserve
The FOMC also reduced the medium outlook of the cash rate by 0.25% for 2016 and 0.5% 2017 and 2018. Based on the most recent outlook, the Fed expects a single rate hike this year, two rate hikes in 2017 and 3 hikes in 2018-2019. Keep in mind, only back in December 2015 the Fed expected 4 hikes in 2016. So it seems very unlikely this rate hike path will be doable in this time frame.
And the way the Fed has been delivering its policy message over the past year has been confusing the markets. Even though the Fed didn’t move the needle on its rates since December 2015 the message has been: “ the market conditions are getting better to support higher rates but it makes more sense to stand by and not raise rates”. No wonder the markets are anxious and don’t really know where rates are heading. And given the concerns over deflationary pressures, low productivity, and other central banks only try to push down their interest rates, the Fed should also be doing this and keep rates unchanged.
Looking forward, the Fed will look at the data and move accordingly. Back at the end of 2015 the last couple of NFP reports were strong, which helped justify a rate hike. This time around, given the growth in jobs should be slower – considering the market is nearing full employment – the Fed will still look for close to 200K jobs per month in the November and December reports.
As a side note, it’s worth noting that the Fed has also been cutting its long term outlook of the unemployment rate from 5.4% back in 2014 to 4.8% in the most recent report. This also suggests the Fed didn’t set its estimate of the natural unemployment rate in stone and may revise it down in the near term. This will become a viable possibility if inflation expectations were to keep falling.
Therefore, even though I also think, much like the market, there is a strong chance of a hike this year; this isn’t a done deal and we will only need another subpar NFP report and lower inflationary pressures or both to hold off this hike to later next year.
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