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The Fed and Interest Rates

Posted by Jeremy Merchant on Jul 1, 2015 5:00:00 PM
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The Federal Open Market Committee (FOMC) met in mid-June to gauge the strength of the U.S. economy and to update its interest rate projections. At the beginning of the year, this meeting had been pegged for the first increase in the federal funds rate since the last recession. However, the odds of an increase at the June meeting, had steadily diminished due to slow growth and benign inflation.

The FOMC voted to keep the federal funds target rate unchanged at the meeting and reiterated that future interest rate policy would be data dependent. The Fed did acknowledge that hiring had picked up since its last meeting in April, in combination with increased household spending and housing activity. However, weakness was also noted in business fixed investment and net exports. Nonetheless, due to the soft patch at the beginning of the year, the Fed downgraded the 2015 U.S. GDP growth forecast to 1.8% - 2.0% from 2.3% - 2.7%.

The FOMC also updated its interest rate projections which is known as the "dot-plot". As expected, interest rate projections were also lowered approximately 25 bps and the first projected interest rate increase was pushed back to September. The "dot-plot" is illustrated below.

fed-funds-target-rate-expectations

Delayed Increase

By again delaying an increase in the federal funds rate, the Fed is telling the markets they are still uncomfortable with the low level of headline inflation as well as their ability to move off of zero to 25 basis points interest rates (currently at 14 bps) without causing excess volatility. Lower inflation has been due, in large part, to the drastic drop in oil prices that occurred late last year and the strengthening of the dollar. These deflationary pressures should subside later this year, however, wage inflation has also been benign. Traditionally, levels of unemployment at or below 5.5% have produced wage growth of 3%. If wage growth of 3% can be achieved (currently at less than 2%), inflation and growth would both move north strengthening the consumer and the U.S. economy.

As the summer proceeds, we expect the Fed to telegraph their intentions to the markets in advance so as not to upset the markets any more than necessary. Based on recent communications from the Fed and federal funds futures, this could be as early as September, with a second incremental increase coming at the December meeting.

As always, please give us a call at (8000 321-9123 if you have any questions.

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Disclaimer: This blog is intended for informational purposes only and should not be construed as individual investment advice. Actual recommendations are provided by RAA following consultation and are custom-tailored to each investor’s unique needs and circumstances. The information contained herein is from sources believed to be accurate and reliable. However, RAA accepts no legal responsibility for any errors or omissions. Investments in stocks, bonds and mutual funds may increase or decrease in value. Past performance is no guarantee of future results. Any of the charts and graphs included in this blog are not recommendations for the purchase and sale of any security. 

Topics: Investment Updates