Unlike previous rate hikes, the Fed’s decision follows a host of economic signals that, at best, sent mixed signals about the course of the economy, says Rob Waas, CEO and CIO of RSW Investments, a Summit, N.J., fixed income manager with more than $2 billion AUM.
“The Fed has to find pockets of strength to point to when they increase rates, but the ledger is stacking up against them pretty decidedly: Personal income is weak, spending is weak, debt burdens are extraordinarily high, and the aging of our society and the decline in birth rates that we have seen is acting as a very strong headwind for growth,” Waas says.
Yet unemployment continues to decline, falling to 4.3 percent in May. In response, the Fed on Wednesday lowered it’s long-term unemployment expectations by a tenth of a percentage point to 4.5 percent. In her comments following the announcement, Federal Reserve Chairwoman Janet Yellen noted that workforce participation rates were holding steady, signaling real improvement in the economy.
In the context of strong unemployment numbers, the Fed's action seems appropriate, wrote Vanguard’s Aliaga-Diaz.
“While the market seems to interpret rate hikes as too hawkish from an inflation perspective, one could make the case they are too dovish given low unemployment rates,” wrote Aliaga-Diaz. “Given these diverging forces, we support the Fed’s decision to take a middle path and modestly raise rates at this time.”
Yellen also sounded confident that economic growth would resume. While the Fed doesn’t expect the U.S. to reach the 3 percent GDP growth called for by President Donald Trump, it increased its 2017 growth projection one-tenth of a percentage point to 2.2 percent.
As such, the Fed did not revise its expectations for rate increases moving forward.
“It’s important to look beyond whether they’re raising or lowering rates, they’re trying to adjust rates to match the current conditions and potential future conditions of the economy,” says Wander. “In the midst of the current environment, where we’re seeing mixed signs of growth, a rate between 1 and 1.5 percent probably makes sense.”
Inflation, a concern at the beginning of the year as proposed fiscal policies offered some potential of stimulating the economy, has subsided in recent months. Many members of the Fed have stepped back from expectations that core inflation will hit 2 percent this year, projecting a 1.6 percent headline rate for personal consumption expenditures. In her comments, Yellen argued that inflation could return to 2 percent by the end of 2018.
The relatively flat numbers, and the Fed’s dovish forward outlook, calls into question the decision to raise rates, some say.