When the Federal Open Market Committee closes its meeting next week, it will likely not conclude with a rate hike. And while that’s good news for borrowers’ wallets now, a new report by Capital Economics states that the Fed cannot stand pat, even though core inflation is clearly rising.
The report, released Wednesday, stated that an “upward revision” in the interest rate is unavoidable. This, the report stated, should be critical because “Fed officials from across the hawk/dove spectrum have stressed that the pace of interest rate hikes this year will be primarily determined by the actual progress made in inflation returning to the 2 percent target."
Relative to December, when the Fed hiked the interest rate for the first time this decade, “officials should be revising their inflation projections higher and leaving their GDP growth and unemployment rate projections unchanged” the report stated. In December, the median projection for the federal funds rate was as high as 1.4 by the end of 2016. This, the report stated, implied four 25 basis point rate hikes this year.
“Assuming those rate hikes came at each of the four FOMC meetings this year with a press conference and projection update,” the report stated, “the Fed should be raising rates next week. Until a couple of weeks ago the Fed could have justified its inaction on the basis of the tightening of financial conditions.”
According to the report, financial conditions have improved markedly in recent weeks. But there is a caveat: while stock markets, the 10-year Treasury yield, and crude oil prices are lower than they were when the Fed raised rates last December, the trade-weighted dollar is slightly higher. However, the report stated, corporate bond yields are lower and some market-based measures of inflation compensation are higher.
“Looking at financial indicators generally, the report stated, “the deterioration that hit a nadir around the time of the January FOMC meeting has now been almost completely reversed.”
Were the FOMC starting with a blank slate next week, the report stated, “we suspect that officials would vote to raise interest rates.” But there is no blank slate, and the fed has been skittish about making any policy changes that might upset financial markets. Understandable, perhaps. But lamentable as far as Capital Economics is concerned.
“We expect the Fed to resume raising interest rates in June (although April isn’t completely ruled out),” the report concluded. “We also believe that a faster-than-anticipated rise in core inflation this year and next will prompt the Fed to raise interest rates more than the markets and other economists anticipate.”