The U.S. central bank is still inching toward its first interest-rate increase in nearly a decade, and it's still likely coming this year. But after looking like it was speeding toward rate hikes as recently as a few months ago, the countdown to rate liftoff has turned glacial.
The U.S. Federal Reserve Board's latest regularly scheduled interest-rate decision statement, released Wednesday, was a remarkable non-event, considering the anticipation. No change to its key federal funds rate (which has sat at a range of zero to 0.25 per cent since late 2008), and no hint that the Fed is any closer to triggering its highly anticipated first rate hike. Only a handful of words were changed from the Fed's previous statement in April, none of them particularly meaningful. The Fed informed us of some modest improvements in the U.S. economy after a bleak first quarter, but otherwise it stuck to its policy guns word for word.
At the same time, the Fed cut its quarterly economic growth forecast to 1.8 to 2 per cent for 2015, from its March forecast of 2.3 to 2.7 per cent, reflecting the estimated 0.7-per-cent annualized contraction in the first quarter. It slightly raised its expectation for the year-end unemployment rate, to 5 to 5.2 per cent from the previous 5.2 to 5.3 per cent.
The Fed's so-called dot plot graph issued together with Wednesday's economic outlook update, which shows where each member of its policy-setting committee expects the federal funds rate to be at the end of the next three years, indicated that a rate hike is still likely before the end of this year. But expectations for the pace of rate hikes, for this year and beyond, have been tempered. Over all, rates are now seen about one-quarter of a percentage point lower at the end of 2016 and 2017 than the officials had previously projected.
The news disappointed many market punters, who have for a while now been pencilling in June, if not as the meeting when the first rate hike was announced, at least as the meeting where the Fed signalled a firm step in that direction. Before the announcement and Fed chair Janet Yellen's quarterly press conference, markets had been pricing in a slightly better than 50-50 chance of a rate hike by October – with the Fed's September meeting looking like the most likely candidate. After the news and press grilling, the markets had pushed back the most likely rate liftoff date to December or January.
The Fed has been very clear that economic data would determine the rate timing – and the poor first quarter has cast considerable doubt over the numbers that have been rolling out. Even as the data have suggested the economy bounced back from the first quarter, which was weighed down by a harsh winter and West Coast port strikes, it's hard to tell how much of the recent improvement is a natural rebound from those first-quarter factors and how much represents an underlying improvement in broader economic momentum.
Critically, the Fed has been saying since March that its policy-setting Federal Open Market Committee will consider rate hikes only "when it has seen further improvement in the labour market and is reasonably confident that inflation will move back to its 2-per-cent objective over the medium term." That reflects the Fed's dual policy mandate: to pursue both price stability and maximum employment. It's a sentiment Ms. Yellen emphasized several times during her news conference.
It's fair to say that both have been giving off mixed signals this year. As of April (the latest numbers), the U.S. consumer price index (CPI) was actually down 0.2 per cent from a year earlier, but it has been confounded by plunging oil prices and a surging U.S. dollar, and lately has shown signs of coming back to life. The U.S. core inflation measure, excluding the volatile food and energy segments, posted its biggest one-month gain in 3 1/2 years in April, and its year-over-year rate of 1.8 per cent suggests that underlying inflation is much closer to the 2-per-cent objective than the overall CPI numbers indicate.
Job growth has moderated from the torrid pace of much of last year. The unemployment rate of 5.5 per cent is near its post-recession low, but it is still about a half-percentage-point above what the Fed considers the natural long-term rate that indicates an economy at full employment. And improvements in the labour force participation rate and the number of involuntary part-timers (people who would prefer full-time jobs) has stalled for months now, at historically elevated levels – suggesting there is still considerable slack in the labour market.
In sum, the numbers we have seen might still point to an eventual rate hike, but they don't demand urgency. Given this year's wobbles in the global growth outlook, the uncertainty surrounding Greece's debts and stock markets looking overstretched (something Ms. Yellen has expressed concern about), it's not hard to make a case for keeping rates steady for an extra quarter at least, rather than rush in and upset a still-delicate global apple cart.
"It's hard to have great confidence in predicting what the market response will be," Ms. Yellen told reporters. "We can't promise that there will not be volatility."
Ms. Yellen made it pretty clear that the key to the timing of a rate hike is jobs. She's counting on a tighter labour market to drive wages higher and be the catalyst for inflation.
National Bank of Canada chief economist Stéfane Marion wrote in a recent research note that in the past, the Fed has held off its first rate hike until full-time employment exceeds its prerecession peak. That's still 475,000 jobs away. At the average pace of full-time job growth this year, that could be achieved in the next two or three months – which would still point to a September liftoff.
But everything the Fed said Wednesday suggests that it won't be comfortable beginning rate increases until the economic evidence is more convincing. Given the first-quarter slump and its impact on a second-quarter rebound, it's unlikely the case will be strong enough before we get well into the third-quarter data flow. That means decision time looks increasingly like the fourth quarter.