Fed Raises Rates and No Longer Considers its Policy “Accommodative”

As expected, the Federal Open Market Committee (FOMC) raised its federal funds target rate range by 25 basis points to between 2 percent and 2 ¼ percent.

The statement’s characterization of the economy was completely unchanged from their previous statement. “The labor market has continued to strengthen and…economic activity has been rising at a strong rate.”

Besides the new interest rate, the only change to the statement was the removal of the sentence noting that: “the stance of monetary policy remains accommodative…”

Near-term economic forecasts were marked to market (reflecting recent strong momentum), but were otherwise largely unchanged relative to the previous Summary of Economic Projections in June:

• The median projection for real GDP growth in 2018 rose to 3.1% (from 2.8%), and to 2.5% in 2019 (from 2.4% previously). The forecast for 2020 was unchanged (at 2.0%), while the newly added 2021 came in at 1.8%, the same as the “longer run” projection.
• The median unemployment rate forecast edged up to 3.7% in 2018 (from 3.6% previously), but was unchanged thereafter at 3.5% for 2019 and 2020. Interestingly, the projection for 2020 is for unemployment to move to 3.7%, still significantly below the longer run estimate of 4.5%.
• On inflation, the median estimate for core PCE was unchanged at 2.1% in 2018, but edged down to 2.0% for 2019 and unchanged for 2020 at 2.1%.
• The median expectation for the federal funds rate was unchanged throughout the projection horizon, with three hikes anticipated in 2019 (bringing median dot to 3.1% by year end), and at least one more in 2020 (median dot at 3.4%). Notably, the median projection for the federal funds rate is anticipated to remain above the longer-run neutral level through 2021.

Key Implications

The most notable thing about this statement was not what it contained but what it left unsaid and what it removed. The statement contained no mention of trade risks and removed the characterization of monetary policy as “accommodative.”

Financial markets may treat the removal of “accommodative” as dovish, but FOMC members are sticking to their guns in expecting further rate hikes. Members have cemented their expectations for at least one more hike this year and continue to see three more hikes in 2019. In a new twist, policy will remain above “neutral” through 2021.

The overshoot of the federal funds rate relative to FOMC members’ longer run assumption is necessary to square the circle between an unemployment rate that remains well under its longer run rate and inflation that barely budges from 2.0%. Risks to the inflation outlook from higher tariffs appear not to be incorporated into SEP projections, but neither are the potentially deleterious impacts on economic growth.