The June Meeting of the Federal Open Market Committee (FOMC) concluded without any surprises or much new news. For the 45th consecutive meeting, the committee voted to leave the Fed Funds Rate at near zero percent. As expected, the central bank said it would continue tapering its bond-buying stimulus program at a steady, measured paced and at the same time, the Fed Reserve lowered its forecast for economic growth. The Fed also suggested it expects to keep the federal funds rate lower than the long-term normal although rate hikes are expected to occur over the coming two years. In a news conference following the Fed statement, Janet Yellen said the highly accommodative stance remains appropriate.
Don’t Fear the Taper
The Federal Open Market Committee decided to make “a further measured reduction in the pace of its asset purchases” and tapered another $10B from its bond-buying stimulus program. Originally purchasing $85B per month of Treasuries and Mortgage bonds, the Fed has been tapering its purchases since January. This latest $10B taper has reduced the purchases to $35B per month. The purchases will be split with $15B in mortgage bond purchases and $20B in Treasury bond purchases. The Fed is on pace to end it bond-buying program later this year.
The Economy Sputters Along
Since the recession, the economy has continued to underperform. Gross domestic product (GDP) grew just 1.8% in 2013, and is projected to increase just 2.1%-2.3% in 2014, down from March projections. GDP is the primary indicator measuring the health of the U.S. economy. It represents the total dollar value of all goods and services produced over a specific time period. The economy has rebounded from the first-quarter slump, but unemployment is still elevated, the Fed said. The unemployment rate has nicely dropped to 6.3% and lower than the Fed’s last meeting however the Fed continues to remain focused on long term unemployment and shadow employment. Yellen remains hopeful that many of the long term unemployed will eventually be drawn back into the labor market as the economy improves.
The economy is strong enough to bring down the unemployment rate, but not strong enough to fuel inflation.
There’s very little sign that the Fed is worried that inflation will spike higher. The current rate of inflation barely exceeds 1%, and it has been in that range for more than a year. . In recent months inflation has heated up; however the Fed gave that little notice. The Fed believes that inflation should run near 2% to promote a healthy U.S. economy. It stresses this point four times in its press statement. Inflation has been running below 2% and is project to remain below 2% for the foreseeable future. In the news conference, Yellen said the Fed sees inflation moving gradually back to 2% over time as the economy expands and is expecting inflation to run between 1.5% and 1.7% in 2014 and between 1.6% and 2% in 2015. She went on to state that inflation remaining persistently below the target could pose risk.
No Change to the Federal Funds Rate
It came as no surprise The Federal Open Market Committee (FOMC) voted to leave the Fed Funds Rate unchanged near 0%, extending the Federal Reserve’s highly accommodative fiscal policy. There has been talk of late that the Fed may be “behind the curve” on rate hikes, however officials are staying the course. Fed officials still think it will be a while before the Fed raises short term interest rates and have contended it will not occur until the bond purchase program has ended. Yellen suggested the Fed is comfortable that it can hold rates steady for a considerable time after it ends the bond purchase program. Most officials think the right timing for the rate hikes will be in 2015. It is also in-line with market sentiment. A majority of Fed officials think that a neutral federal funds rate – a rate neither too loose nor too tight – is 3.75%. That is a change from the March projections when most thought the neutral rate was 4%. Should the Fed begin hiking rates, it will take a couple of years to reach this higher level.
Over the past 35 years, the federal funds rate has averaged over 5%.
Investors should not take ultra-low rates for granted. It is important “for market participants to recognize that there is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be,” Yellen said. When discussing rate hikes, Yellen said, “The committee is confident it has the tools it needs to raise short-term interest rates” when necessary, and the Fed “will continue to have a very large balance sheet for some time.”
What Will Mortgage Rates Do?
As a buyer of mortgage bonds, the Federal Reserve raised demand, which in turn, caused prices to fall, thus lower mortgage rates. As the Fed continues to taper its purchasing of mortgage bonds, mortgage rates are expected to rise.