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  Fed Tilts Hawkish
Posted Under: Government • Research Reports • Fed Reserve • Interest Rates

 

After hiking rates in December, the chances of another rate hike from today's meeting were close to nil.  But where changes, mostly modest, were made to today's statement, they point to a more hawkish stance. 
 
You can ignore the wording change to the language focused on economic growth and employment gains, but recent data seems to have boosted the Fed's confidence that inflation is moving towards their 2% target. The Fed made two noticeable change when discussing inflation: 1) language regarding the impacts from energy and trade prices holding down inflation were removed, and more importantly 2) the Fed changed language from "inflation is expected to rise" to "inflation will rise" to 2% over the medium term.  As we pointed out in this week's Monday Morning Outlook, average gains of 0.2% per month for the January and February readings are all that are required for the PCE index – the Fed's favored measure of inflation – to hit 2% year-to-year growth. To put that in perspective, the PCE index has shown gains of 0.2% or more in four of the last five months. 

Today's statement also added language noting improvement in consumer and business sentiment in recent months.  Why add this language when it hasn't been a focus in the past? If the data releases since the last Fed meeting are any indication, this confidence is leading to a pickup in business activity meaning more jobs and increased demand for goods. And given an unemployment rate already below the Fed's identified long-run target level, continued job gains point to higher wages and rising consumer spending.

All eyes will now be on the next Fed meeting in March. While some may argue that today's meeting didn't set the stage for a March hike, the hawkish tone will likely turn some heads. At a minimum, the economic projections and press conference accompanying the next Fed meeting should provide a clear picture on when the next rate increase will occur. 
 
We expect the Fed will raise rates 3-4 times in 2017, starting in June if not before. This pace of hikes is in-line with the "dot plot" projections the Fed released in December.  Economic fundamentals warrant higher rates, and the Fed would have been justified to raise rates today.  The economy can handle higher short-term rates. Employment remains healthy and nominal GDP – real GDP growth plus inflation – has grown at a 3.2% annual rate in the past two years.  Moreover, we are seeing signs of accelerating inflation.  "Core" consumer prices are up 2.2% versus a year ago, tied with the largest increase since 2008, while average hourly earnings are up 2.9% from a year ago, despite many highly paid and productive Baby Boomers exiting the workforce.
 
Slightly higher short-term rates are not going to derail US growth, but will help avoid the misallocation of capital that's inevitable if short-term rates remain artificially low.   

Brian S. Wesbury, Chief Economist
Robert Stein, Dep. Chief Economist

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Posted on Wednesday, February 1, 2017 @ 3:14 PM • Post Link Share: 
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