The twists and turns of speculation on when the Federal Open Market Committee’s will raise interest rates never seem to cease. First, in March the FOMC softened its forward guidance and signaled that rate hikes were going to be on the table at every FOMC meeting going forward, starting in June. Then, several Fed speakers weighed in with a variety of views on monetary policy. Finally, last week the minutes from the March 17–18 FOMC meeting were released. Yet no clear and consistent message has emerged.
Some of this new information suggests the FOMC will begin to normalize rates soon, whereas some of it suggests just the opposite. How is an intelligent investor supposed to negotiate between myth and reality? Let’s break this down, bit by bit.
Myth: Communication from the FOMC is hopelessly muddled and confusing.
Reality: Given the cloudiness in the Federal Reserve’s economic crystal ball, it only makes sense for the FOMC to be noncommittal and open to a range of possible actions.
The economic outlook for the U.S. is unclear. The mixed messages coming out of the FOMC accurately reflect the divergent opinions about what to do, given the circumstances. Some economic signals — specifically, the unemployment rate and the creation of jobs — are reading hot and urging normalization of rates sooner rather than later. Other indicators — inflation, wage growth and consumer spending, to name a few — are urging patience in raising rates so as not to quash tenuous economic growth. Don’t expect Fed communication to be clear and consistent until the numbers tell a clear and consistent story about the economy.
Myth: The FOMC will begin to normalize rates in June.
Reality: A rate hike is possible at the June FOMC meeting but is more likely at the end of this year.
A June rate increase was very much on the table following the most recent FOMC statement and the release of the minutes of the March meeting. But that was before a weak jobs report earlier this month. “I can imagine a situation where a June rate hike could still be in play,” noted New York Federal Reserve president William Dudley after the disappointing jobs announcement. “But obviously, it’s a bigger hurdle because we’ve had a lot of weak data. Now you have to see sufficient data on the other side. Now the bar is a little higher.” Dudley added that recent data “has very much surprised to the downside” and that “it’d be reasonable to think that the timing of the Fed’s first rate hike might be a little further off in time.”
For its part, the FOMC has been very responsive to the ebbs and flows of economic data. In my view, inflation, wage growth and spending data will remain soft at least through the third quarter, and the FOMC will not be comfortable increasing interest rates before December.
Myth: The timing of an initial rate hike will determine future interest rates.
Fact: The specific timing of the Fed’s first rate hike may be great for financial news network ratings, but it has very little to do with where interest rates will be in the future.
Normalization of interest rates will not occur in one giant leap but rather will involve multiple incremental raises. It only stands to reason that the pace of subsequent rate hikes will have far more influence on the future path of interest rates than the timing of the first one. Indeed, it is the pace of tightening that will influence the shape of the yield curve for years to come.
Fed chair Janet Yellen confirmed this notion in a speech in late March, commenting that the FOMC will “carefully deliberate about when to begin” normalizing rates. Yellen added, “What matters for financial conditions and the broader economy is the entire expected path of short-term interest rates and not the precise timing of the first rate increase.” Focusing on the interest rate hike without accounting for the macroeconomic backdrop as a whole might be losing sight of the forest for the trees.
Shehriyar Antia is the founder and lead strategist at Macro Insight Group, an investment strategy firm based in New York. Previously, he worked on quantitative easing programs and monetary policy as a senior market analyst at the Federal Reserve Bank of New York.
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