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Fed keeps rates unchanged, sees fewer rate hikes for year

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The Federal Reserve on Wednesday did exactly what the financial markets were expecting: nothing. It left interest rates unchanged, maintaining the Fed Funds rate — the rate that banks charge each other for overnight loans — at 0.25 percent to 0.50 percent. 

Fed policymakers also lowered expectations for growth this year to 2 percent, from 2.2 percent previously, and reduced the lower end of its range for longer run outlook to 1.6 percent to 2.4 percent from 1.8 percent to 2.4 percent.

Given the more dovish outlook, it’s not surprising that six of the 17-member Fed’s policy making Federal Open Market Committee now expect just one rate hike this year instead of two. Only one member held that forecast after the Fed’s last policy meeting, and Fed expectations for 2017 and for 2018 now call for three rate increases each year, down from four. The also lowered its long-run outlook for Fed Funds to 3 percent from 3.3 percent

In her press conference following the release of the Fed’s statement, Fed Chairwomen Janet Yellen “highlighted how the payrolls data slowed ‘markedly’ in April and May … and the data merit close watching,” said Jim O’Sullivan, chief U.S. economist for HFE. “She is making the case for being very cautious with any policy changes.”

Financial markets had little reaction. The Dow Jones Industrial average initially gained about 10 points to 17,745 within minutes of the release of the Fed statement, then retreated slightly. The yield on the 10-year Treasury note initially didn’t budge, then fell slightly before inching up to 1.59 percent.

“The statement seemed very cautious,” said Anthony Valeri, Fixed Income and Investment Strategist for LPL Financial. “It seemed to have some concern about the pace of labor market improvement and about inflation running below target.”

Indeed, the statement began, noting that “the pace of improvement in the labor market has slowed while growth in economic activity appears to have picked up. Although the unemployment rate has declined, job gains have diminished.”

That was clearly the case in May when payrolls rose by just 38,000 (73,000 if adjustments were made for striking Verizon workers), well below expectations.

For investors and advisors the Fed’s decision means a “low return environment will be in place longer,” said Valeri. That’s a negative for bond investors already collecting little income from their holdings but it also reduces concerns about rising interest rates, said Valeri. On the plus side, it’s a “mild positive” for equity investors because lower rates support higher stock valuations, said Valeri. He expects mid-single digit gains for U.S. stocks this year; they’re already up 2.5 percent year-to-date.

Paul Eitelman, investment strategist for North America at Russell Investments, noted in his written comments following the Fed statement that “any pause in rate increases is apt to be fairly short. The U.S. labor market is effectively at full employment and there are an increasing number of signs that inflation is moving back up toward 2 percent. With the Fed’s dual mandate close at hand, the hiking process will resume as soon as the FOMC can re-establish confidence that the outlook for both the labor market and broader economy are still on track.”

Eitelman says the Fed’s September meeting is the “likeliest timing for the Fed’s next move.”

See also:

Insurers mark significant regulatory shift

10 financial predictions for 2016

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