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The Fed Thinks Global
By Zane Brown
The central bank’s concern for developments overseas may have informed its decision, on March 16, to scale back rate-hike projections.
The U.S. Federal Reserve (Fed) has made a point of emphasizing that it will be “data dependent” in formulating any future policy moves. However, the Fed threw markets a curve on March 16 by citing recent turmoil in global markets, as it held the fed funds target rate steady at 0.25–0.50%—and scaled back projections for additional rate hikes in 2016 and beyond.
The communiqué released at the conclusion of the two-day meeting of the Fed’s policy-setting arm, the Federal Open Market Committee (FOMC), started in typical fashion, stating that U.S. economic activity was “expanding at a moderate pace”—but the words that followed came as a bit of a surprise—“despite the global economic and financial developments of recent months” [emphasis added]. The fact that the FOMC elevated global developments as a primary concern overshadowed its assessment that the labor market was strengthening and that inflation, though still low, had “picked up in recent months,” indicating progress toward its objectives of full employment and 2% inflation. The prominence of the Fed’s global concerns was especially striking, given the fact that commodity prices have recovered from their recent lows and that global markets have stabilized in recent weeks.
In the “dot-plot” projections released in conjunction with the FOMC statement (see Chart 1), policymakers reduced rate-hike expectations for 2016, to a total of two, 25 basis-point increases, from the four that were expected just this past December. The change brought the Fed into alignment with Wall Street expectations, as indicated by fed funds futures. The March 16th update now puts the median projection for the fed funds rate at 0.9% by year-end, down from 1.4% in December, and the 2017 year-end projection at 1.9%, down from 2.4%. The 2018 year-end projection fell, from 3.3% to 3.0%.
Chart 1. Connecting the Dots on the Direction of Fed Policy
Federal Open Market Committee assessment of appropriate fed funds rate, 2016–onward (as of March 16, 2016)
Source: U.S. Federal Reserve. Each shaded circle indicates the value, rounded to the nearest one-quarter percentage point, of an FOMC member’s view.
Forecasts and projections are based on current market conditions and are subject to change without notice.
Projections should not be considered a guarantee.
The FOMC statement also was notable for a hawkish dissent by one of its members, Esther George, the Kansas City Federal Reserve Bank president, who voted against the Fed’s action and instead preferred a rate hike at the March meeting.
Financial markets reacted routinely: In the wake of the FOMC’s 2:00 p.m. ET announcement on March 16, Treasury yields increased, while stocks erased earlier losses to move higher. The dollar index weakened.
As we mentioned earlier, the Fed’s sudden dovish turn came despite substantial progress toward its stated objectives. Specifically, unemployment at 4.9% is within the Fed’s longer run estimate of 4.8–5.0%, and marginally above its December 2015 central tendency forecast of 4.6–4.8% for both 2016 and 2017. Core PCE inflation at 1.7% is close to the Fed’s 2.0% target, and if last year’s positive effects of oil-price and currency movements are transitory, headline inflation could advance soon as well. Perhaps the March statement reflects the Fed’s desire to get ahead of any future market troubles in China, Japan, Europe, and elsewhere. If so, policymakers have added an unstated third mandate—maintaining order in global financial markets—to their traditional employment and inflation charges.
Zane Brown is a Lord Abbett Partner and Fixed Income Strategist.
