The suite of communications from the March FOMC meeting reveals a Committee that is much more attuned to risks emanating from abroad, and thus willing to take a more cautious approach to policy normalization. There were signs of this greater focus on risk management considerations in the inter-meeting communications, particularly in speeches by Governor Brainard and President Dudley; today revealed that their concerns about downside risks are shared more widely on the Committee. As such, today’s communications are notably dovish for a Committee that still remains intent on raising rates this year. For example, while the policy statement did not bring back a full assessment of the risks to the outlook, it nevertheless noted that “…global economic and financial developments continue to pose risks”. The Chair elaborated on these risks in her press briefing, highlighting a number of countries experiencing slower growth. In addition, despite the firming in inflation over recent months, the policy statement continues to emphasize that inflation is running below the Committee’ objective, that it is expected to remain low in the near term, and that market-based measures of inflation compensation remain soft.
The Summary of Economic Projections similarly reflects the Committee’s growing appreciation of downside risks and the restraining effects of slowing global growth. Judging from the median economic projections, the Committee continues to anticipate above-trend growth this year and next and a gradual return of inflation to two percent. However to achieve these outcomes, Committee members anticipate a notably flatter path of policy rates. The median policy rates projected for year-end 2016 and 2017 each came down by 50 basis points, to reflect 50 basis points of policy tightening this year and 100 basis points next year. Tellingly, the highest policy rate projections for 2016 and 2017 came down by even more than the median projections – even the more hawkish members seem to appreciate the challenges associated with sustaining interest rate increases in an environment of weakening global growth and divergent monetary policy stances.
For some time now I have expected the Committee to only raise rates twice this year, bringing the interest rate on excess reserves to 100 basis points by the end of the year. I see no reason to change this call after today. Growth thus far in the new year has been somewhat unimpressive, tracking a bit above trend for the first quarter. And as I have written elsewhere, there are several variables that may be signaling downside risks to growth, such as the deceleration in service sector activity surveys, tighter bank lending standards for commercial and industrial loans, and declining corporate profitability. Still, the Committee can feel confident that the economy has performed with a fair degree of resilience in the face of headwinds from abroad. Members are also likely heartened by easing measure taken by other central banks, particularly as these measures have not led to dollar appreciation. Further, even if growth is slowing towards trend, there is growing evidence that inflation is gradually firming. This may continue if there is additional progress in reducing remaining labor market slack and if oil prices do not revisit their February lows.
As for the timing of an additional rate increase, June remains a possibility, but a lot has to “go right” to bring this about. The Committee will want to see that the recent firming of inflation does not prove short-lived, and that inflation expectations continue to move higher. They will also seek confirmation that growth is not slowing to a below-trend pace. In this regard, some of the key variables to watch include payrolls, consumer spending – which has been running on the soft side recently – and surveys of service sector activity. In addition, indicators of global growth momentum also bear close watching; here as well, the news has not been particularly encouraging, judging by the global PMI data.