Investable Thinking® Blog
Timing the Fed's Next Move
Thanos Bardas, PhD
Portfolio Manager and Global Head of Interest Rates
SEPTEMBER 23, 2014
With the U.S. Federal Reserve about to wrap up its asset purchase program, the countdown has intensified as to when rate
hikes will begin. While trying to interpret "Fed-speak" can be a full time job, it has consistently said that incoming data will
ultimately drive its actions. In our view, it's possible that the slow path toward rate normalization won't begin until late 2015.
The Fed presented a balanced view at its September meeting. The central bank all but assured that its asset purchases would end in November 2014. But it remained dovish by
saying that rates could be on hold for "considerable time" after the end of quantitative easing. At the same time, future rate forecasts from FOMC members were more
hawkish. All told, the central bank was far from definitive as to when rates hikes will begin, and Fed Chair Janet Yellen repeatedly said that its next move would be data
dependent.
FOMC's Current View
Against this backdrop, it's uncertain when rate hikes will begin. Looking at the quarterly polling of the 17 FOMC members, there's a strong consensus that policy normalization
will begin in 2015. Where do they think rates will be at the end of next year? As shown below, their views are largely clustered between 0.75% and 2.0%. But there's
significant dispersion in the outlook for 2016, with no clear consensus on where rates will end that year. This makes sense, as the FOMC members appear as much in the dark
as anyone in terms of the economy's trajectory two years from now.
FOMC Member Views: Appropriate Fed Funds Level (%)
Source: Federal Reserve. Each dot indicates the view of a FOMC member as to the midpoint of the appropriate target range or the appropriate level for Fed Funds rate at the
end of each year.
Fed vs. Market Expectations
How do market expectations compare to the Fed's current point of view? As shown in the chart below, the FOMC's projection for the trajectory of rates has progressively
increased over the past year.
The Fed's Rate Expectations Are on an Upward Trend
Source: Federal Reserve views on Fed Funds rate, as of September 2014.
Market expectations, as measured by Fed Funds futures, remain lower than those of FOMC members.
FOMC vs. Fed Funds Rate Projections (%)
FOMC Expectation
Market Expectation
(Fed Fund Futures)
2014
0.125
0.100
2015
1.375
0.760
2016
2.875
1.820
End of
Source: Source: Bloomberg, data as of September 17, 2014.
Our Current View
Where do we stand in terms of when normalization begins? As of today, our best guess is in the latter stages of 2015. Here's why:
Future U.S. Growth
While better than earlier in the year, it's far from robust—a trend we expect to continue. The Fed appears to agree, as it just lowered its expectations for GDP in the coming
years—consistently lower than its long-term average.
Fed U.S. Economic Growth Projections
Projection Date
2014
2015
2016
2017
Longer Run
December 2013
2.8% – 3.2%
3.0% – 3.4%
2.5% – 3.2%
N/A
2.2% – 2.4%
September 2014
2.0% – 2.2%
2.6 – 3.0%
2.6 – 2.9%
2.3 – 2.5%
2.0 – 2.3%
Source: Federal Reserve, September 17, 2014. The central tendency excludes the three highest and three lowest projections for each variable in each year.
Labor Market
Yes, the unemployment rate has declined over the last year. But it has been fairly stable in recent months, with a historically low participation rate. As such, we agree with
the Fed that "there remains significant underutilization of labor resources."
Benign Inflation
The combination of modest growth and tepid wage pressure likely means subdued inflationary pressures in the year to come.
Collectively, we believe this adds up to a balanced Fed, but not one that will not rush rates hikes and jeopardize the currently modest economy recovery.
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