Outside the Beltway

Federal Reserve Declines To Raise Rates Again

Once again, the Federal Reserve chooses to pass on the opportunity to raise interest rates.

Doug Mataconis · Thursday, June 16, 2016 · 7 comments

After several less than stellar economic reports, including a very disappointing May Jobs Report, the Federal Reserve Board again held interest rates steady after its meeting this week and hinted that it is reevaluating its previously announced plan to gradually increase rates over the coming year:

WASHINGTON — The Federal Reserve did not raise its benchmark interest rate on Wednesday, and the central bank said it expected to raise rates more slowly in coming years, an acknowledgment that economic growth had again disappointed its expectations.

The Fed is struggling to adapt its plans to the reality of an economy that refuses to boom. Seven years after the official end of the Great Recession, the economic news remains mediocre. The Fed, in a statement released after a two-day meeting of its policy committee, noted what had become a typical mix of good news and bad.

Economic growth has picked up while job growth has declined, the Fed said. Consumers are spending more; companies are making fewer investments. Britain’s looming referendum this month on whether to leave the European Union has added still more uncertainty.

“Recent economic indicators have been mixed, suggesting that our cautious approach to adjusting monetary policy remains appropriate,” the Fed chairwoman, Janet L. Yellen, said at a news conference after the statement’s release.

In this environment of tepid growth and weak inflation, Fed officials once again dialed back their expectations for future rate increases. The Fed entered the year predicting four rate increases this year. On Wednesday, the Fed released new projections that showed 15 of the 17 policy makers expected no more than two hikes this year, and six of those officials expected just a single rate hike.

The median prediction is now that the Fed’s benchmark rate will rise to just 2.4 percent by the end of 2018, down sharply from the March median of 3 percent.

The decision to wait was unanimous. Even Esther L. George, president of the Federal Reserve Bank of Kansas City, did not want to raise rates. She voted for a hike at the Fed’s last few meetings, but this time she agreed the moment was not ripe.

“The labor market appears to have slowed down, and we need to assure ourselves that the underlying momentum in the economy has not diminished,” Ms. Yellen said.

The Fed’s next meetings are in July and September. Investors already are heavily discounting the chances of a rate increase in July, and September’s chances also have fallen sharply. Those chances, derived from asset prices, stood at just 12 percent and 28 percent on Tuesday, according to the Chicago Mercantile Exchange.

The Fed’s post-meeting statement said the domestic economy was feeling less drag from the weakness of the global economy, noting that exports had strengthened. But Ms. Yellen said that the Fed continued to worry about a relapse. She said one factor in the Fed’s decision to leave rates unchanged was concern about the potential impact of Britain’s referendum on its continued membership in the European Union. A breakup could be economically disruptive, she said.

Fed officials increasingly think the economy has exited its post-crisis period, according to economic projections the central bank published on Wednesday. The recovery, in other words, may be incomplete, but it is also over.

Most officials predicted stable economic growth around 2 percent over the next few years, and they foresaw little if any additional decline in the unemployment rate, which fell to 4.7 percent in May. They expected inflation to reach the Fed’s desired 2 percent annual rate in 2018.

The Fed, which entered the year planning to raise rates four times, has scaled back those plans as economic growth has disappointed expectations. The Fed’s benchmark rate remains in a range between 0.25 percent and 0.5 percent.

The 4.7 percent unemployment rate is the lowest level since 2007, and Fed officials have pointed to signs that wages are starting to rise more quickly. But the Fed has hesitated to move. Officials see little reason for urgency, because inflation continues to rise more slowly than the Fed’s 2 percent annual target.

Officials also see significant risks in moving too quickly. Because interest rates are already low, the Fed has little room to ease conditions if growth falters. Officials say it would be easier to respond to faster inflation than to an economic downturn.

More from The Wall Street Journal:

WASHINGTON—The Federal Reserve held its benchmark lending rate steady on Wednesday and officials lowered projections of how much they expect to raise short-term interest rates in the coming years, signs that persistently slow economic growth and low inflation are forcing the central bank to rethink how fast it can move rates higher.

“We are quite uncertain about where rates are heading in the longer term,” Chairwoman Janet Yellen said at a press conference following the Fed’s two-day policy meeting.

New projections show officials expect the fed-funds rate to rise to 0.875% by the end of 2016, according to the median projection of 17 officials. Their forecasts imply they see two rate increases this year. That is the same number of increases they saw when they last released projections in March. However a greater number of officials now see one increase, rather than two. In March only one official saw one rate increase this year and seven saw three or more. Now six officials see one increase this year and only two see three or more.

Ms. Yellen said a rate increase at the Fed’s next meeting in July is “not impossible,” but she doesn’t know how quickly officials will gain confidence the economy is on firm footing. “We need to assure ourselves that the underlying momentum in the economy has not diminished,” she said.

The central bank also sees the fed funds rate at 1.625% by the end of 2017 and 2.375% at the end of 2018, lower than quarterly projections officials released in March. Three months ago the median estimate for rates in 2018 was 3%. In the longer run, the Fed expects its benchmark rate to reach 3%, lower than the 3.25% they saw in March.

These projections aren’t set in stone, but they do indicate how officials’ views are changing. The Fed doesn’t see rates going as high as it saw before, and it sees taking a longer time to get to the endpoint officials have in mind

“Recent economic indicators have been mixed, suggesting our cautious approach to adjusting monetary policy remains appropriate,” Ms. Yellen said.

The upcoming British referendum on whether to leave the European Union was also a factor in Fed officials’ decision to leave rates unchanged, and “clearly could have consequences” for economic and global financial markets, the Fed chief added. “If it does so, it could have consequences in turn for the U.S. economic outlook that would be a factor in deciding on the appropriate path of policy,” Ms. Yellen said of the so-called Brexit vote, set for June 23.

In their official policy statement released after the meeting, Fed officials repeated the refrain they’ve been using all year that they expect “economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.”

The central bank in December pushed its benchmark interest rate up from near zero to between 0.25% and 0.5%.

So far, the economy and financial markets haven’t cooperated with plans to keep moving rates up. Early in the year, market turbulence and slow growth in economic output gave officials pause. Growth appears to have picked up and markets settled down, but now hiring and expected inflation are a cause of concern for officials, a mixed backdrop making them reluctant to act.

“The pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up,” the Fed said. While consumer spending has strengthened, business investment has been soft. Meantime, market indicators of expected inflation have declined, the Fed said, a development Ms. Yellen noted earlier this month was of some concern.

The tone of the Fed’s official statement and projections suggest officials will need to see a quick turnaround in economic data and evidence of market resilience if they are to move promptly.

The Fed indicated its views about risks to the economy haven’t shifted much since April. As they said then, officials said they would “closely monitor” inflation indicators and global economic and financial developments. That isn’t a strong endorsement of the outlook. At moments of more confidence, as in December when the Fed raised short-term interest rates by a quarter percentage point, the Fed said risks to the economy were balanced.

The Fed slightly reduced its estimate for how much economic output will expand this year, shifting its March projection of 2.2% output growth to 2%. It also nudged down its 2017 growth projection by one tenth of one percent to 2%. At the same time it nudged up its inflation projection for the year to 1.4% from 1.2%, but held most of its other projections steady. The combination of relatively stable economic projections and a lower interest rate outlook suggest officials are slowly coming to the conclusion that the economy simply can’t bear very high interest rates, even to achieve mediocre growth and low inflation.

(..)

The decision not to raise rates Wednesday follows recent comments from Ms. Yellen that officials want to wait for more assurance the hiring slowdown is not a harbinger of underlying weakness in the broader economy.

After a round of disappointing recent economic reports, including very disappointing jobs reports for April and May that included significant downward revisions for previous months it’s not entirely surprising that the Federal Reserve made this decision. At the same time, though, it does constitute yet another departure from the plan that the Fed’s Board of Governors had set for itself that would have involved rate increases like the one we saw in December on at least a quarterly basis throughout 2016, and probably through 2017 as well. These would have constituted the most significant changes to lending rates in the United States since well before the Great Recession actually began, and the first move off of what have effectively been zero interest rates in over seven years. Even at the time, critics said that the Fed was moving too quickly with even modest rate increases. The economic data, they argued, was hardly as a strong as the Fed was contending, and the fact that there is essentially no evidence at all of a looming inflation threat, there was no need to move quickly on rates when the risk that such a measure could slow growth in an already weak economy was so high. Being the bastion of inflation hawks it has always been, though, the Fed decided to go ahead with the rate increase, arguing in part that it could not keep rates at a near-zero level forever and that the economy and the stock market needed to be allowed to float on its own without artificial support from historically low interest rates.

As the year has gone on, though, the Fed has seemingly proven the critics right, or at least accepted their argument that the urgency for higher interest rates was far less apparent than it might have seemed at the end of 2015. On each of the occasions that it has had the opportunity to raise rates this year, the Fed has punted the decision to its next meeting, just as it did last year until finally biting the bullet at the end of the year. As it did in 2015, the main reason the Fed cited for demurring on rate increases is the fact that the underlying economic data, as well as international factors such as the continuing apparent slowdown in China, historically low oil prices, and the Brexit vote in Great Britain, all of which are or could have a real impact on economic growth in the United States.

Looking ahead, it’s hard to see the domestic economy improving significantly from where it is right now, and there are plenty of signs that it could actually weaken in the months to come. Given that, it’s hard to see the Federal Reserve actually raising rates again between now and the end of the year. Furthermore, as we get closer to the election the chances of a rate increase will likely decrease since the Board of Governors has historically been reluctant to act close to an election in a way that could unduly influence the outcome of the election. Obviously, if the data changes and the economy appears to be growing at a faster pace than it has been for most of the year then it would probably be wise for the Fed to revisit its interest rates decision. For now, though, maintaining the status quo would seem to be the wisest choice.