Fed Stays Course, But Looks for Exit Ramp

One-third of Governors Vote for Immediate Rate Increase

The Federal Open Market Committee, as expected, held the federal funds rate steady yesterday following its policy meeting. But the vote was far from unanimous, and the FOMC statement appeared to crack the door for a future rate increase a bit wider.

The committee noted the employment gains and inflation concerns suggest that a widely anticipated rate hike could happen sooner than later. “The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives,” the statement said.

Mortgage Bankers Association Chief Economist Mike Fratantoni also noted the FOMC change of tone. “Echoing comments from a recent speech by Chair Janet Yellen, the statement indicated that the case for a federal funds rate increase has strengthened,” he said. “Although they decided to not raise rates this month, we continue to expect they will raise rates in December.” 

Fratantoni said other Federal Reserve officials are sounding increasingly hawkish in their public remarks, highlighting the risks to the economy from keeping rates too low for too long. “Those public statements were backed up by dissents from three voting members of the FOMC, who would have preferred to increase rates at the September meeting,” he said. “It is exceedingly rare to see this level of public disagreement at the Fed.”  

Fratantoni added FOMC voters indicate in their projections for the economy that most anticipate a rate hike before the end of the year. “Markets continue to be confused by the divergent messages being sent by different Fed voices, and perhaps as a result, longer term rates were little changed immediately following the FOMC announcement,” he said. “In the press conference following the announcement, Chair Yellen emphasized that the still low level of inflation was the primary reason that the Fed chose to keep rates unchanged at this point.  She also said explicitly that she expects a rate hike this year.”  

MBA reported last week in its Weekly Mortgage Applications Survey that mortgage application volume dropped in response to a relatively small increase in mortgage rates. “We continue to expect that refi activity will fall off through the remainder of 2016 and into 2017, but that purchase activity will be robust, backed by the strength of the job market,” Fratantoni said.

The FOMC statement appears below:

Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year. Although the unemployment rate is little changed in recent months, job gains have been solid, on average. Household spending has been growing strongly but business fixed investment has remained soft. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.