Fed downshifts on pace of rate hikes

Putnam Investments, 4/14/2016


With the Federal Reserve dialing back its pace of interest-rate hikes, investors have a new piece in the puzzle for determining their strategies.

When the Fed increased the federal funds rate by 0.25% at its December meeting, the general belief was that the central bank was embarking on a tightening regime similar to the steadily paced increases of recent cycles. At its March meeting, however, the Fed cited a slowdown in overseas growth and turmoil in the financial market as reasons to hold rates steady, leaving the federal funds rate unchanged at its current range of 0.25% to 0.5%.

The slow and steady path to "normal"

Following the March meeting, Fed Chair Janet Yellen said Federal Open Market Committee (FOMC) members believe that “a somewhat slower path” for rate hikes may be necessary to achieve the central bank’s goals for the U.S. economy.

Since the recession, the Fed has kept interest rates low to reduce unemployment and bring inflation up to its target of 2% a year. After reaching those goals, the Fed would in theory be able to raise interest rates back to what is considered in the “normal” range for recent history — a federal funds rate of between 3% and 4%.

All eyes on the "dot plot"

The “dot plot,” a quarterly graphical representation of individual forecasts by 17 Fed policymakers, released after the March meeting, showed a reduction in the number of rate hikes for 2016 — down to two from the four expected in December.

The FOMC’s latest dot plot also revealed a median projection for the federal funds rate of 0.9% by the end of this year, before increasing to 1.9% in 2017 and 3% in 2018. This compares with December, when policymakers’ median projections were for a 1.4% federal funds rate by the end of this year, and 2.4% and 3.3% by the end of 2017 and 2018, respectively. FOMC members’ median forecast for real GDP growth this year also was reduced to 2.2% in March from 2.4% in December, which is the equivalent of a $36 billion reduction in output.

It’s important to note that the rate projections are by no means a guarantee for future monetary policy. However, the downward movement in these projections during the past quarter is an acknowledgement of headwinds to growth. For those pursuing investments that carry interest-rate risk, the shift provides a clue to help formulate strategy.

Conflicting views within the Fed

Meanwhile, more hawkish members of the FOMC have indicated that the next rate hike should be sooner rather than later. They include Federal Reserve Bank of St. Louis President James Bullard who said policymakers should consider raising interest rates at their next meeting in April. He cited an unchanged economic outlook and the prospects of inflation and unemployment exceeding the central bank’s targets.

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