Fed in Limbo, Less Concerned About Global Headwinds

The Federal Reserve faces a dilemma. It wants to raise interest rates, but the economy is not delivering growth that a buoyant labour market and healthy consumers would suggest even with international developments, like China’s slowing economy, being less of a headwind than it was in March.

For the third straight meeting, the U.S. central bank did not assess the balance of risks, which adds more uncertainty about the timing of the next rate hike. By stating whether it believes the risk is the economy underperforms, overperforms, or remains roughly balanced, one can glean how confident Fed members are in the economy.

“I think they’re in limbo now,” says Millan Mulraine, Deputy Chief U.S. Macro Strategist with TD Securities USA. “I think June is off the table.” Mulraine doesn’t see the Fed hiking in June and maybe not even in July until it is able to assess the balance of risks.

“The minutes are likely to show that opinions are too divergent to draft a statement that gets into the timing of rate hikes ahead,” said CIBC chief economist Avery Shenfeld in a note.

No rate hike was expected from this April Fed meeting. The Fed funds target range was kept at 0.25 to 0.50 percent.

Emphasizing the more domestic-focused nature of the statement, the Fed demoted the reference to “global economic and financial developments” from the March statement’s opening line to the last sentence of the second paragraph. It also removed the phrase “global economic and financial developments continue to pose risks.”

The Fed also noted that household spending hasn’t been as robust given households’ real income rose “at a solid rate and consumer sentiment remains high.”

The Fed’s “quandary,” as Mulraine puts it is what matters to the Fed is real economic activity even if sentiment and fundamentals appear positive. 

“The fact that they’re now talking about slowing growth momentum and moderated consumer spending suggests that that’s where the focus is right now and I think that will be the key area of emphasis going forward,” Mulraine says.

“I think they have to be confident that that is actually translating into economic activity before they start contemplating raising rates,” Mulraine says.

“That I think is the whole theme of this statement.”

“June may simply be too early to have enough fresh data on hand to provide such conclusive evidence of a return to faster household spending,” said Shenfeld.

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From its March projections, the median appropriate level for the key policy rate indicated two 0.25 percent rate hikes in 2016. Those rate hikes look unlikely for the first half of 2016.

Mulraine sees at most one rate hike coming in the second half of the year.

For the second meeting in a row, Kansas Fed president Esther George dissented with the rest of the committee, voting for a 0.25 percent rate hike in April.

The Fed’s next meeting is in mid-June. New projections for economic growth, unemployment, and inflation will be provided and Fed chair Janet Yellen will hold a press conference.

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