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First, the expected: At the end of this week’s two-day meeting, Federal Reserve policymakers kept the target funds rate effectively at zero, continued the pace of monthly tapering at $10 billion, acknowledged the economy was improving but, as a result of a brutal winter that brought first-quarter activity to halt, also lowered its forecast for growth for the year. Now for the news: What wasn’t certain is when and by how much the Fed may start to raise rates, and on that front, policymakers did some juggling. In their updated economic projections, they signaled the initial increases could be a little sooner and higher in 2015 and 2016 than the market had been anticipating, but when all is said and done and the Fed is through raising rates, the overall increase could be a little lower, too.
It wasn’t a dramatic change but enough to indicate the funds rate could start to move a few months earlier than the mid-2015 consensus, ending the year closer to 1.25% vs. the previously estimated 1% and closer to 2.5% than the previous 2.25% at the end of 2016. That’s consistent with the Fed’s forecast that the unemployment rate will decline a little faster than previously projected, to as low as 6% this year, 5.4% next year and 5.1% in 2016. At the same time, the so-called dot chart that reflects each policymaker’s vote on the fund’s future levels also showed a lowering of the equilibrium rate, i.e., the longer-term neutral funds rate. It now stands at 3.78%, down from 3.88% in March and 4.21% in January 2012, when the dots first began appearing as part of former Chairman Ben Bernanke’s push to be more transparent about the Fed’s thinking. This lends credence to the view that the longer-run growth rate may be lower because of demographic and structural changes, which in turn should act to keep both the funds rate and longer rates lower, too.
Notably, compared with the last forecast following March’s meeting, there was one more “dot’’ in the 0% to 0.25% range for next year, prompting some to speculate it represented the view of new Vice Chairman Stanley Fischer, who was unable to vote in March because he had yet to be confirmed. No one knows if that’s the case, of course, but if it is, it would only add to the appearance that the Fed under new Chair Janet Yellen could lean dovish and be supportive of the “risk-on’’ trade—equities rallied following release of the statement and the updated projections accompanying it, and continued moving up as Yellen laid out her views in a subsequent press conference.
To be sure, the composition of the policy-setting Federal Open Market Committee is changing all the time—in March, two people dropped off and three were added—so changes in its longer-term views could be less due to philosophical changes at the Fed and more due to personnel shifts.
One other item of interest is that the Fed chose to ignore the recent uptick in inflation, stating only that the core Personal Consumption Expenditures Index—the Fed’s preferred gauge of inflation—continues to run below its 2% target. This would seem to underline a dovish bias at the Fed, again supportive of asset prices.