Anticipating the Fed statement today, I wanted to see how the FOMC (Federal Open Market Committee) would address the key questions it needs to answer before deciding when next to raise rates. I expected the FOMC to acknowledge that the U.S. economy appears to have rebounded in the second quarter from the very soft first-quarter growth, but to caution that labor market improvements – especially as reported in the very disappointing May payrolls report (published on 3 June) – have slowed. I also expected the FOMC to acknowledge that measures of inflation expectations have softened. In other words, I expected today’s statement to “mark to market” the flow of data received since the April meeting.
And the first paragraph of the statement did exactly that. Importantly, the statement did not downgrade its assessment of survey-based measures of inflation, even though Fed Chair Janet Yellen did discuss this specifically in her 6 June speech in Philadelphia.
The rest of the statement was largely unchanged from the previous statement in April. It did not mention “Brexit” risk specifically as a factor influencing the June decision. Instead, the June statement maintains the April language that the FOMC would closely monitor “global economic and financial developments.” Neither did today’s statement say – as did the October 2015 statement – that a rate hike could well happen at the “next meeting.”
So while the June statement did not rule out July, it did not signal that a hike at the next meeting is likely. This reflects, I believe, a desire to see whether the disappointing payrolls report on 3 June was a blip or instead the start of a pronounced softening of the labor market.
Finally, I expected the “blue dots” in the FOMC’s new Summary of Economic Projections (SEP) to indicate via the median dot that two hikes are projected for 2016, and that the longer-run destination for the policy rate would shift down to 3%, and this is indeed what the June SEP shows. That said, six members of the FOMC project only one hike in 2016, and three members of the FOMC see a longer-run neutral rate of 2.75%. This places now nine members of the committee in the New Neutral camp that PIMCO has been discussing for the past two years. Finally, the FOMC also now projects only three hikes in 2017 and 2018, down from four in each of those years in the March SEP. The committee also continues to indicate that it wants to run the labor market “hot” in order to push the unemployment rate below the estimated non-accelerating inflation rate of unemployment (NAIRU) of 4.8%, its current level.
In sum, the Fed with its June statement today maintains its optionality to hike when it sees fit. But the FOMC again falls short in laying out a framework to understand or predict how this decision will be made. “Data dependence” is not a monetary policy, and the dot plot is not a reaction function. Investors in the U.S. and around the world are scrutinizing central bank policy and asking whether, over the longer term, it may be exhausting its ability to spur economic growth and inflation. That uncertainty is a major factor of PIMCO’s secular outlook of an insecure stability.
Richard Clarida is a managing director in PIMCO's New York office and the company's global strategic advisor.