As was widely expected, the Federal Open Market Committee (the FOMC) raised its key interest rate 25 basis points to a range of 1.50 percent to 1.75 percent following its March meeting. The Fed noted that its decision reflected “realized and expected labor market conditions and inflation”, but that the current level of the federal funds rate remains “accommodative”, supporting strong labor market conditions and a sustained return to two percent inflation.
In addition, the FOMC communicated that the median FOMC projection now indicates more hikes in 2019 and 2020 than it previously expected for those years back in December 2017. The median of FOMC members’ projections of the federal funds rate implies three 25 basis point rate hikes in 2018, unchanged from December, but now three additional 25 basis points rate hikes in 2019, up from a median expectation of about two in December, with a firming of two more 25 basis point rate hikes in 2020, up from a median expectation of either one or two in the December projections release.
The newly released FOMC projections suggests that the additional hikes now expected in each of 2019 and 2020 largely reflects greater tightening of labor market conditions corresponding with expectations of faster inflation. In his press conference, Chairman Powell also expressed concern about asset prices, including prices for commercial real estate, a sentiment also shared by former Chair Yellen.
The FOMC’s statutory mandate is to foster maximum employment and price stability. In targeting maximum employment, the FOMC noted that the labor market has continued to strengthen and that economic activity has been rising, though at a moderate rate in 2018 due to slower growth in household spending and business investment. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong.
With regards to price stability, the FOMC noted that both overall inflation and inflation for items other than food and energy have continued to run below 2 percent. The FOMC’s preferred measure is consumer prices associated with the personal consumption component of GDP, but so-called “core” inflation in the CPI displays a similar trend. In addition, market-based measures of inflation compensation have increased in recent months but remain low; survey-based measures of longer-term inflation expectations are little changed, on balance.
However, inflation on a 12-month basis is now expected to “move up in coming months” and to stabilize around the Committee’s 2 percent objective over the medium term. In January, the FOMC expected inflation to “move up this year”. Previous NAHB analysis demonstrated that higher inflation can impact the housing market through the mortgage rate channel. However, continued income growth should offset this erosion of affordability to a degree.
In addition to its statement, the FOMC also updated its highly anticipated Summary of Economic Projections. According to these projections, the median FOMC member expects the federal funds rate to rise by 75 basis points in 2018 similar to its expectation in December, 75 basis points in 2019, more than the 56 basis point increase expected in December, and 50 more basis points in 2020, more than the 38 basis point increase expected in December. Assuming these hikes are all 25 basis points, this translates to three rate hikes in 2018, three more in 2019, up from approximately two hikes expected for 2019 back in December, and two more hikes in 2020, a firming from the uncertainty of one or two hikes expected for 2020 back in December.
Although the median FOMC projection of 75 basis points in hikes for 2018 was unchanged from December’s projection, the underlying economy is now expected to be a bit stronger as the median GDP projection for 2018 was raised 0.2 percentage point to 2.7 percent and the median unemployment rate was lowered 0.1 percentage point to 3.8 percent. In 2019, the median projection for the federal funds rate rose from 56 basis points to 75 basis points as the median projection for GDP (+0.3 ppt to 2.4 percent), the unemployment rate (-0.3 ppt to 3.6 percent), and inflation (+0.1 ppt to 2.1 percent) changed.
In 2020, the median FOMC projection for the federal funds rate rose from 38 basis points to 50 basis points as the median projection for the unemployment rate (-0.4 ppt to 3.6 percent) and inflation (+0.1 ppt to 2.1 percent) changed. The median projection for economic growth remained unchanged in 2020 at 2.0 percent. While the changes in the outlook for economic conditions and monetary policy will rightly be interpreted as a change in the FOMC’s view, that change may also reflect the myriad of membership changes that have taken place between December 2017 and March 2018 as well.