What’s next from the Federal Reserve?
We have traditionally used outtakes from the Federal Open Market Committee (FOMC) meetings, their dot plot charts, and their stated economic milestones to formulate our viewpoints for future interest rate activity on the part of the Federal Reserve (“Fed”). What we have found throughout the course of 2016 is that this perhaps is not the most prudent approach as accurately predicting Fed activity based on any of these measures appears to be an exercise in futility. Regardless, I will provide an update on their most recently stated positions, prior to their November meeting, to help provide some clarity to an otherwise unclear process.
We currently believe that there will be one interest rate hike of 25 Bp in 2016, likely announced after the FOMC meeting in December, leaving the Federal Funds Target Rate in the range of 0.50% – 0.75% by the end of the year. This forecast is in line with the Fed’s current median projection for 2016 based on the last released forecasts of the FOMC participants stemming from their September 2016 meeting (see table below) but arguably more aggressive than some market pundits who believe that the Fed may actually sit on their hands for the balance of 2016 and not raise rates at all this year.
What is interesting to note from the most recent “dot plot chart” from the voting members of the Federal Reserve, which is summarized in the table above, is how all of their projections were lowered for 2016, 2017, 2018 and for their longer run estimates in September from their earlier reported estimates in June and March. It is also noteworthy to appreciate the wide range in opinion amongst the voting members, particularly in the year of 2018, and how one voting member actually forecasts a federal funds target rate as low as 0.60% as far out as 2018. As a result, based on current data and forecasts, though trying to predict future Fed activity is often a daunting task as previously discussed, it is fair to conclude that interest rates will remain relatively low for the foreseeable future.
When the Fed does restart its tightening program, we still believe that they will likely follow the blueprint that it utilized during the 2004-2006 tightening period when it gradually raised the Federal Funds Target Rate on 17 different occasions in 25 Basis Point (i.e. 0. 25%) increments over this timeframe. The only difference during this round of tightening that we see is that the Fed may also consider starting to slowly shrink the size of their U.S. Treasuries and Government Agencies securities laden balance sheet over time, in conjunction with gradual increases to the Federal Funds Target Rate. In other words, instead of just considering raising rates further after each FOMC meeting, they may consider some form of a gradual 1-2 punch of rate increases and sales of U.S. Treasuries (or non-reinvestment of the principal of existing maturing bonds) off of their balance sheet.