This week’s U.S. economic news was dominated by the Federal Reserve and their monetary policy announcement of March 18. As expected, the FOMC removed the word “patient” from their forward guidance on interest rates. FOMC chairwoman Janet Yellen, in her post-FOMC-meeting press conference, made a point of saying that the removal of the word patient does not mean that the Fed is impatient about raising short-term interest rates. Nonetheless, it does mean that the Fed has taken another step toward interest rate lift-off and monetary policy normalization.
Yellen also said that the fed funds rate would not be changed at the next FOMC meeting over April 28/29. This brackets interest rate lift-off sometime over the five FOMC meetings from mid-June through mid-December. It is most likely that the FOMC will announce lift-off at a meeting that is followed by a press conference. This reduces the choices to three meetings…June 16/17, September 16/17 or December 15/16. We eliminate the December meeting by looking at the March 18 dot plot of FOMC members’ expectations about the appropriate pace of policy firming. The dot plot shows that a strong majority of the FOMC believe that the fed funds rate should be at 50 basis points or higher by the end of 2015. They would likely not get to 50 basis points by the end of 2015 if they start lift-off on December 16.
This leaves either June 17 or September 17 as the most likely dates for interest rate lift-off. In her press conference, Yellen was asked specifically about the June date, and she would not rule that out. However, the Fed is strenuously trying to show that the date is not pre-determined, and that the exact timing of interest rate lift-off will be data dependent. Aside from the normal focus on labor market metrics and inflation, the rising value of the dollar and the falling cost of crude oil are complicating the analysis.
We believe that the Fed will continue to view the deflationary pull of low oil prices as a transient event, as they will the deflationary pull of low import prices due to a strong dollar. The headwinds against export growth from a strong dollar may be more lasting if they result in a structural adjustment to U.S. export industries. However, we believe that the Fed will maintain a strong focus on the potential for wage inflation as the unemployment rate descends through this year. We forecast the unemployment rate to average 5.0 percent in 2015Q4, slightly lower than the central tendency of the economic projections of the members of the FOMC, at about 5.1 percent.
Even though the exact timing of interest rate lift-off may not yet be determined, the Fed will want to manage financial market expectations about lift-off in order to minimize shocks to financial markets. We expect the Fed to strongly telegraph its intention to raise the fed funds rate at least one meeting prior to lift-off. Given our expectation that lift-off will most likely occur in June, we expect to see a strong hint of that at the next FOMC meeting over April 28/29. Absent that hint at the end of April, our expectation for lift-off shifts to September.
Collectively, members of the FOMC, including Janet Yellen, have implied that the upward trajectory of the fed funds rate will be shallower than it has been in previous lift-off cycles. The Fed’s dot plot shows FOMC members’ expectations of a shallow increase in the fed funds rate to near 3 percent by the end of 2017.
For a PDF version of the Comerica Economic Weekly, including forecast tables and the variables calendar, click here: CMAEconWeekly 03-20-15.