As was widely expected, the Federal Open Market Committee (FOMC) held the target range for the federal funds rate unchanged between 1-1/2 and 1-3/4 percent.
The views of the FOMC participants appeared little changed from those during the March meeting round, with the statement reiterating the themes of moderate growth, low unemployment, and strong job gains, although the qualifier “on average” was added to the latter, suggesting the Fed is looking through month-to-month volatility in payroll growth.
In light of the recent GDP report, the Fed also reiterated that consumer spending has moderated from its rapid Q4 pace, while fixed business investment was viewed as having grown strongly.
The Fed’s take on inflation was notably different. The statement indicated that inflation has now “moved close” to target – previously it “continued to run below” target in the Fed’s eyes. Moreover, the outlook was changed from expected to “move up in the coming months and to stabilize around” the objective to now “run[ning] near” the 2 percent target.
Notably, the 2 percent objective was preceded with the word “symmetric”.
Interestingly, the Fed’s take on the improvement in market-based measures of inflation compensation was largely discounted, with the fact that they “have increased in recent months” struck out of the statement altogether, with the FOMC viewing them as still “low”.
Risks were seen as balanced, but the Committee went out on a limb expanding the phrase to cover longer term risks also. Previously the statement was explicitly limited to “near-term” risks. Moreover, the FOMC decided to delete the sentence that it will be “monitoring inflation developments closely” from the statement altogether.
Key Implications
On the surface the May statement appeared to be a lackluster one, with no change in rates and only a few wording changes in the statement. However, many of the wording modifications were quite notable.
The most noteworthy changes were related to the Fed’s take on inflation, which was now viewed as close to target, where it was expected to remain over the medium run. Previously, the Fed was just hopeful that such a scenario would play out. From that perspective, well done Powell and Co. Still, much of the credit should likely go to Janet Yellen and Co., who kept rate hikes gradual and set up the rebound in inflation.
Another small but notable change is the addition of the “symmetric” word before the reference to inflation objective. This was certainly not accidental and suggests that the Fed will continue to tighten policy to prevent inflation from overheating, but is not likely to overreact and may tolerate above target inflation to some extent – just the way it tolerated inflation readings below 2%, working diligently to raise it but not panicking by slashing rates.
These changes, together with the fact that the Fed appears to now be far more comfortable with the risks facing the economy, set the Fed up for a June hike – barring any unforeseen shocks. They also suggest that the FOMC will continue to tighten policy over the medium term to ensure inflation does not overheat. We expect two more hikes this year, but a slightly faster pace of tightening is not out of the question.
