As was widely expected, the Federal Open Market Committee (“FOMC”), the monetary policy making body of the Federal Reserve, maintained the federal funds rate at a range of 1.50 to 1.75 percent following its meeting that convened on May 1-2, a rate it deems “accommodative”. Going forward, the FOMC expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term, labor market conditions will remain strong, and inflation on a 12-month basis will run near the Committee’s symmetric 2 percent objective over the medium term. At its next meeting, financial markets widely expect, as shown in the figure below, the FOMC to raise the key interest rate by 25 basis points to a range of 1.75 to 2.00 percent.
The FOMC seeks to foster maximum employment and price stability. With respect to the labor market, the FOMC indicated that job gains have been strong, on average, in recent months and that the unemployment rate has stayed low. On the inflation front, the FOMC noted that both overall inflation and inflation for items other than food and energy have moved close to 2 percent.
The monetary policy action mentioned in the May statement, which was approved by all eight members of the FOMC, was also important for language that was revised from its last meeting. For example, in its March meeting, the FOMC noted that “The economic outlook has strengthened in recent months.” That sentence was omitted in the May statement. In addition, in March, the FOMC noted that “Near-term risks to the economic outlook appear roughly balanced, but the Committee is monitoring inflation developments closely.” In May, the sentence was revised to “Risks to the economic outlook appear roughly balanced.” In addition, the FOMC used the word “gradual” twice in its statement to reinforce the pace of rate hikes, which is consistent with the updated estimate of the output gap given CBO’s new estimate of potential GDP.
As discussed in an earlier post, the most recent Summary of Economic Projections, released with the March meeting indicated that, at the median, the FOMC expects three rate hikes in total for 2018, one of which took place in March. However, the anonymized recordings of each individual FOMC member’s expectations about the number of rate hikes over 2018, commonly known as the dot plots, are about evenly split between three and four hikes for the year, or two or three more hikes over the rest of 2018.
Financial markets still expect closer to two more rate hikes in 2018, but expectations are moving toward three and the revised language in the May statement hasn’t immediately altered that view. The figure above uses information on prices of federal funds futures contracts that trade on the Chicago Mercantile Exchange. The price between any two months can be interpreted as financial markets’ expectations about the total basis point increase in the federal funds rate over that period. The figure above uses the difference between the price on the May 2018 contract and the price on the January 2019 contract.
The chart above illustrates that on February 13th, when NAHB began collecting the data, and March 12th expectations rose from 39 basis points to 49 basis points. Assuming each rate hike is 25 basis points, then one interpretation is that financial markets moved from being evenly divided between one or two hikes to a consensus around two more hikes in 2018. Expectations fell slightly between March 12th and April 6th but most market participants still expected two rate hikes over the remainder of the year. Since April 6th, market expectations for the basis point increase in the federal funds rate over the year has continued to rise and now eclipses 50. This suggests that financial markets still agree with the FOMC’s view of two rate hikes for the remainder of the year, but the agreement is diverging as more financial market participants expect three more rate hikes for 2018.