Fed Sets Stage For December Rate Hike

Today’s statement from the Federal Reserve sets the stage for a December rate hike. The key issue is whether the next two reports on the labor market, the one coming out late next week and the one released in early December, show a reacceleration in jobs gains or continued drops in the unemployment rate. At present, we expect both, which suggests the Fed will start a long-awaited series of rate hikes in December.

Two major changes to the Fed’s statement hint at a Fed rate hike. First, the Fed took out the reference to global economic and financial developments possibly restraining economic growth and putting downward pressure on inflation. In other words, like some investors, it was too concerned at the September meeting with what was going on in China.

Second, when listing the factors that would guide its decision on interest rates – progress toward maximum employment and 2% inflation – the Fed didn’t refer to “how long” it would maintain its current target for short-term rates. Instead, the Fed said it would use these factors “(i)n determining whether it will be appropriate to raise the target range at its next meeting”. That’s pretty specific. They had been using the prior open-ended language, with no specific meeting reference, dating back to December 2012. We see that as a big shift and a key signal to the markets.

The Fed made two other less important changes to the statement. It acknowledged that the pace of job gains has been slower lately, but also noted better growth in consumer spending and business investment. We think these two relatively minor changes offset each other, one more hawkish, the other more dovish.

It is long past time for the Federal Reserve to start raising short-term rates. The unemployment rate is already very close to the Fed’s (new, lower) long-term projection of 4.9% and set to fall further in the next year, even if the Fed had already started lifting rates. Nominal GDP growth – real GDP growth plus inflation – is up at a 4.1% annual rate in the past two years, slightly exceeding the Fed’s long-run projection of 4% growth.

At least one voting member at the Fed agrees. Once again, Richmond Fed Bank President Jeffrey Lacker dissented from today’s statement; he would have raised rates by 25 basis points today. However, it now looks increasingly likely that Lacker can stick to his position and won’t have to dissent in December.

As long as the data cooperate, look for a 25 basis point rate hike in December followed by a rate hike at every other meeting, four rate hikes in all, in 2016.

This information contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.

© First Trust Advisors

© First Trust Advisors

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