Late last year we had a great chart that showed the Fed’s own expectations for tightening were ahead of the markets’ expectations for Fed tightening. We explained that as those two outlooks moved toward one another there would be volatility. On this past Wednesday, we experienced the positive aspect of that volatility.
Fed officials concluded two days of meetings in Washington and issued a statement regarding the economy and interest rates. While many were focused on the language used by the Fed, we were more focused on the Fed governors’ expectations for short-term interest rates in the coming year and the lowering of the theoretical “full employment rate”.
As part of Federal Open Market Committee (FOMC) meetings, each of the Fed Governors plots what they expect the Fed Funds rate to be at the end of 2015, 2016 and 2017. This chart has been referred to as “The Dot Chart”. The median expectations of the governors for Fed Funds at the end of 2015 actually came down from 1.125 percent to .625 percent. This means that the Fed Governors still expect to raise rates in 2015 (which we expect as well), but just not as quickly as they previously expected. This is more in line with what the market was hoping for; thus it was met with both a stock and bond market rally.
Unemployment has been one of the most controversial topics of this economic expansion. The unemployment rate steadily moved down from 10 percent in 2009 to 5.5 percent in February. This rapid decline stood at odds with what many people felt they were experiencing in their own lives, and what was anecdotally highlighted in the media as well. What makes this more than a theoretical conversation is the unemployment rate’s effect on wages.
The most recent Federal Reserve study on employment came to the conclusion that the “full employment rate” for the U.S. economy was approximately 5.4 percent. The belief being that at 5.4 percent unemployment wages would start to rise or even accelerate. In the Fed’s statement today, they lowered the theoretical full employment rate for the United States to between 5.0 percent and 5.2 percent. Because we have not seen wages increase up to this point, they concluded that a lower level of employment would be needed to begin to pressure wages higher. This conclusion fits perfectly with the expectations of Fed Governors that the Fed Funds rate would not be increasing as much as previously expected. One company of note is Target, which announced this Thursday that they would be increasing wages for employees to at least $9/hour in April.
Takeaways for the Week:
- The Fed continues to signal that they will be raising rates later this year, but at a pace that agrees with the markets’ assessment of our economic situation
- Future Fed meetings and communications will cause increased volatility in the market