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On December 16, 2008 the Federal Open Market Committee slashed its target for the federal funds rate to a range of between 0% and 0.25% from the already low 1% rate. The FOMC wrote at the time: "Since the Committee's last meeting, labor market conditions have deteriorated, and the available data indicate that consumer spending, business investment, and industrial production have declined. Financial markets remain quite strained and credit conditions tight. Overall, the outlook for economic activity has weakened further."
More than six years later the federal funds rate remains at this historically low level but the economic picture has changed drastically -- albeit slowly. Wednesday the FOMC took a small but significant step toward beginning to raise interest rates by issuing guidance that opens up the possibility of a hike as soon as June.
The committee has dialed back its optimism on the U.S. economy slightly since January but remain more bullish than it has been in years. The new statement says:
Information received since the Federal Open Market Committee met in January suggests that economic growth has moderated somewhat. Labor market conditions have improved further, with strong job gains and a lower unemployment rate. A range of labor market indicators suggests that underutilization of labor resources continues to diminish. Household spending is rising moderately; declines in energy prices have boosted household purchasing power. Business fixed investment is advancing, while the recovery in the housing sector remains slow and export growth has weakened. Inflation has declined further below the Committee's longer-run objective, largely reflecting declines in energy prices. Market-based measures of inflation compensation remain low; survey-based measures of longer-term inflation expectations have remained stable."
On the policy guidance front the change is the removal of a single word -- patient. Starting in December 2014 the Fed used this word in its policy statement to describe its stance on raising rates. For two meetings the statement said: "Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy."
It now says: "Consistent with its previous statement, the Committee judges that an increase in the target range for the federal funds rate remains unlikely at the April FOMC meeting. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
Those two sentences have big implications. For months Fed Chair Janet Yellen and her band of economists have tried to act as financial soothsayers by carefully defining what patience -- and ultimately its absence -- means for monetary policy. At the same time, they've tried not to say too much to avoid setting on a path they can't stick with if economic conditions change.
Yellen visited Capitol Hill twice last month. There she provided the most significant insight yet into the course ahead, saying the word patient would be removed before a rate hike occurs. That moves she said would signal that the committee would consider a rate hike at each subsequent meeting. Yellen had previously defined "patient" as “a couple”of meetings and agreed that “a couple” means two. In her Congressional testimony she clarified that changing the guidance meant the Fed could act in two meeting, not that it would.
This hedge was reiterated in the new statement which pointed out, "This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range." Yellen also reiterated in the first moments of here press conference, saying, "Just because we removed the word patient from the statement doesn't mean we're going to be impatient."
The removal of patient, therefore, means that a rate hike could come in June. (On this possiblity Yellen said, "This change does not mean that an increase will necessarily occur in June. Although we can't rule that out.")
Prior to the release the market's view was that a move will come in June or September. (Most people are betting the FOMC will only act at a meeting that is followed by a press conference. The Fed chair hosts press conferences at alternating meetings. The July meeting will not include a conference and there is no meeting in August.) But new projections from FOMC members are leading some prominent economists to believe September is more likely.
"The March FOMC statement and projections suggested that September rather than June appears to be the most likely date for the first hike of the fed funds rate. Although the change to the 'patient' forward guidance was close to expectations, the shift in the 'dot plot' was most consistent with two rather than three 25 basis point hikes to the target range occurring in 2015. In addition, changes to the Committee's economic assessment were a bit more dovish," explained Goldman Sach's Chief Economist Jan Jatzius in a note on the Fed actions. The mid-point of the FOMC members' projections for the fed funds rate fell to 0.625% at the end of 2015, 1.875% at the end of 206 and 3.125% at the end of 2017.
As a result of the more dovish projections U.S. equity markets had a sharp reversal into positive territory Wedensday afternoon. Stocks were in the red leading up to the statement release at 2 p.m. and press conference at 2:30 p.m. Minutes after the statement became public all three major stock indices swung firmly into the green. While Yellen spoke the S&P 500 crossed 2,100, the Dow Jones Industrial Average crossed 18,000 and the Nasdaq briefly crossed 5,000.
Meanwhile the yield on the 10-year Treasury note dropped to 1.95% following the release after spending the earlier part of the day between 2.01% and 2.05%. The VIX, a volatility measure from the Chicago Board Options Exchange, was at around 14 through Yellen's talks from around 16 through the day and compared to an average of 17 so far this year.
Another reason for the swing was the widely held belief that patient would be removed from the statement. "If it is in fact becoming somewhat consensus and you want to take [patient] out why not do it now? Do it now because it is not going to be a big surprise to the market," said Michael Arone, investment strategist for State Street Global Advisors, in an interview prior to the Fed release.
With a recent lull in corporate news, market swings in the last two weeks especially have been driven by investor interpretations of how the FOMC would respond to economic data. This has at times meant that good news about the economy has led to a downturn in stocks as investors worried the Fed would run out of reasons to keep rates low and cut back on return boosting liquidity. For example, two weeks ago the Bureau of Labor Statistics said the unemployment rate had dropped to 5.5% -- the lowest rate since May 2008 -- stocks went south. Bad economic news has at times also bolstered stocks.
In a letter last week to Bridgewater Associate clients billionaire hedge fund manager Ray Dalio summed up the conundrum he and many other investors feel they are faced with. He wrote, "Since our confidence that the Fed can be effective in tightening is greater than ever while our confidence in the Fed's ability to be effective in easing is less than ever, we think it would be best for the Fed to err on the side of being later and more delicate than normal." In other words, he knows the Fed can raise interest rates but can they bring rates back down if necessary? Dalio continued, "To be clear, we don't know -- nor does the Fed know -- exactly how much tightening will knock over the apple cart."
Not all investors agree with this take and few investors -- Dalio included – believed before the meeting that the Fed will deviate from the June or September hike expectations they have set.
