As we said back in March, mark your calendars for a rate hike on June 15. Today's statement from the Federal Reserve signals that it intends to raise rates by 25 basis points at the next meeting, consistent with the projections it made in March that it would raise rates twice in 2016.
Here's why we think the Fed is headed toward a June rate hike.
First, the Fed re-ordered the list of economic indicators it discusses in the first paragraph of its statement, making the labor market first and noting its continued improvement. That's important because many key decision-makers at the Fed have said a tighter labor market will eventually lead to higher inflation.
Second, although the Fed mentioned more moderate growth in consumer spending, it also noted "solid" growth in household income and "high" consumer sentiment. In other words, the Fed expects growth in consumer spending to accelerate.
Third, the Fed completely removed the language about "risks" due to "global economic and financial developments." Remember that it was exactly these risks that stopped the Fed from raising rates earlier this year. We interpret the removal of this language to mean the Fed sees the risks to its March economic outlook as balanced, which means it's also comfortable with its March projection of two rate hikes.
In addition, like in March, the one dissent came from Kansas City Fed Bank President Esther George, who voted in favor of hiking rates by 25 basis points at today's meeting.
In our view, George was right and everyone else wrong. Economic fundamentals warrant a rate hike. The economy can handle higher short-term rates. The unemployment rate is already very close to the Fed's long-term projection of 4.8% and nominal GDP growth – real GDP growth plus inflation – is up at a 3.5% annual rate in the past two years.
Slightly higher short-term interest rates are not going to derail the US expansion, 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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