Fed sends careful rate hike signal

The Federal Reserve sent markets a cautious signal that it’s planning to raise rates this year, after its latest two-day policy meeting left the benchmark lending rate at zero.

As anticipated, the US central bank held off from raising the federal funds rate, but left the door well and truly open for it do so later this year.

Notes from the June meeting showed 15 of the 17 policymakers think rates will increase this year. Markets are betting on this happening in September, but the Fed left plenty of room for guessing to continue.

The Federal Open Market Committee (FOMC) said the labour market “continued to improve, with solid job gains and declining unemployment”, but that “inflation continued to run below the Committee's longer-run objective”.

“The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labour market and is reasonably confident that inflation will move back to its two per cent objective over the medium term,” the Fed said in a statement.

No overt signal

The Fed did not send an overt signal about the timing of the rate hike, but it’s clear that September is coming into focus.

Rick Rieder, chief investment officer of Fundamental Fixed Income at BlackRock thinks the Fed is signalling the economy is ready for an initial lift-off of policy rates before year end.

“We still believe that the FOMC’s September meeting is the most likely date for this lift-off, with December a real possibility too.”

Slowly does it

Even when the Fed does eventually pull the trigger, the pace of raising rates will be important.

“We would argue that the precise timing of the event is much less important than the pace of policy rate change, as well as the ultimate destination of the terminal rate,” adds Rieder.

The Fed is evoking the same language as the Bank of England, stating that there is a strong chance rates won’t return to historic averages any time in the near future.

“The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run,” the FOMC said.

In terms of the pace and destination of the federal funds rate, the Fed been at pains to be clear that the path of rate change will be gradual and the long-run terminal rate lower than the 4.25 per cent historic norm.

Fed chair Janet Yellen has consistently used the term “gradual” to describe the trajectory of policy rates.

Data-dependent

The two key metrics for the Fed are unemployment and inflation and with September’s meeting not far away, the first week of August will be key.

Non-farm payrolls data on Friday August 7th could be critical for the Fed’s decision. Recent reports have shown a strengthening labour market but anything below forecast may raise doubts about whether the US economy is ready to handle to higher rates.