FOMC Meeting—December 15-16, 2015
Nariman Behravesh, Sara Johnson, and Ozlem Yaylaci
Bottom line
- As expected, the Federal Open Market Committee (FOMC) raised the federal funds rate by 25 basis points at its December 15-16 meeting—the decision was unanimous.
- This was the first rate hike in more than nine years—and seven years since rates were pushed to zero.
- The so-called “dot plot” (the expectations of Fed officials regarding future interest rate hikes) suggests that there will be four 25 basis point rate increases in 2016. The median year-end rate expectation at the December meeting was 1.4% for 2016, 2.4% in 2017 (down from 2.6%) and 3.3% in 2018 (down from 3.4%).
- The long-run target for the federal funds rate was left at 3.5%—unchanged from its September forecast.
- The Fed motivated the rate hike by saying that economic activity is “expanding at a moderate pace” and that “underutilization of labor resources has diminished appreciably”.
- On the other hand, the FOMC statement commented that inflation has been running below its 2% target, although it attributed this to declines in energy prices and the prices of non-energy imports (because of a strong dollar).
- The Fed’s anxiety about low inflation was evident in the FOMC’s commitment to “carefully monitor actual and expected progress toward its inflation goal.”
- Finally, the committee stated that it “expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.”
Outlook: The Fed has embarked on the slowest tightening cycle in a long time.
On the basis of economic fundamentals, the rationale for the Fed hike was debatable. On the one hand, the US economy is on a solid footing. On the other hand, inflation is still a distant threat. The Fed’s preferred measure of inflation—the deflator for core personal consumption expenditures (which excludes energy and food)—has been relatively stable at around 1.3% for the past few months. This is well below the Fed’s target of 2%.
Nevertheless, given the long drum roll that has preceded this first rate hike in nearly a decade (countless press stories and speeches by US monetary officials), the Fed would have lost credibility if it had not raised rates. As IHS Global Insight has said in the past, Fed Chair Janet Yellen and her colleagues were eager to get this first hike out of the way. They are now likely to proceed very slowly. IHS Global Insight expects four 25 basis point increases in 2016 (in March, June, September and December) and four more in 2017.
While US monetary policy will become tighter over the next couple of years, it will be far from tight. For example, by the end of 2016 (and also 2017) the federal funds rate will be well below the 2006 peak of 5.25%. Just as important, real (inflation adjusted) short-term interest rates will likely still be below zero at least through the middle of 2017.