Consistent with market expectations, the Federal Open Market Committee (the FOMC) left the Fed Funds rate unchanged, at 0.25%‐0.50%.
After pausing at the April meeting in the face of slower Q1 GDP despite significantly easier financial conditions, the Fed was limited this month in its ability to raise rates, in front of the EU Referendum vote on June 23rd. The statement was designed to emphasize that the Fed expects 1) to continue to gradually hike rates and 2) to remain dependent on the economic outlook, specifically inflation developments, as well as global economic and financial conditions.
We can break the Committee’s statement into three parts:
The Summary of Economic Projections showed that the Fed’s long-run expectations remained unchanged, but the path toward achieving those objectives reflected greater uncertainty. The Fed continues to see further improvements in the unemployment rate. Although the path of inflation was upgraded in 2016 modestly, inflation is expected to remain below its objective for the next 2 years. The Fed also released the famous “Dot Plot”. The path of the Federal Funds rate is now flatter and consistent with the Committee’s higher uncertainty on the path of economic developments and the lower long-run Federal Funds Rate. The terminal Fed Funds rate fell by 25 bps lower, while expectations for 2018 fell even more dramatically (down by ~60 bps).
At the press conference, Chair Yellen remained cautious in light of recent labor market developments but felt that the balance of the data continued to allow her to forecast a rebound in Q2 GDP and inflation to rise slowly to the Fed’s target. Her caution reflected the uncertainty around the fundamental data and a need for further confirmation of her outlook. The Chair suggested the Fed could remain more accommodative in the near-term to achieve their medium term objective. With short term rates near zero, an inflation overshoot could be managed more effectively than a slowdown in the economy.