Fed Raises Interest Rates and Signals 2 More Increases Are Coming
Posted June 13, 2018 8:46 p.m. EDT
Updated June 13, 2018 8:47 p.m. EDT
WASHINGTON — The Federal Reserve raised interest rates Wednesday and signaled that two additional increases were on the way this year, as officials expressed confidence that the U.S. economy was strong enough for borrowing costs to rise without choking off economic growth.
Jerome H. Powell, the Fed chairman, speaking in unusually blunt terms at a news conference Wednesday, said the economy had strengthened significantly since the 2008 financial crisis and was approaching a “normal” level that could allow the Fed to soon step back and play less of a hands-on role in encouraging economic activity.
The Fed’s optimism about the state of the economy is likely to translate into higher borrowing costs for cars, home mortgages and credit cards over the next year as the central bank raises interest rates more quickly than was anticipated.
Wednesday’s rate increase was the second this year and the seventh since the end of the Great Recession and brings the Fed’s benchmark rate to a range of 1.75 to 2 percent. The last time the rate topped 2 percent was in late summer 2008, when the economy was contracting and the Fed was cutting rates toward zero, where they would remain for years after the financial crisis.
“The decision you see today is another sign that the U.S. economy is in great shape,” Powell said after the Fed’s two-day policy meeting. “Most people who want to find jobs are finding them.”
The increases this year are part of a gradual series of steps to return rates to historically normal levels, and they reflect both the Fed’s confidence in America’s economic strength and its commitment to bring the inflation rate to its target of 2 percent.
But the march toward higher interest rates comes as much of America’s workforce continues to experience slow wage growth, despite a tight labor market that should, in theory, translate into higher wages as businesses compete for workers.
The rise in consumer prices over the last year has effectively wiped out any wage increases for nonsupervisory workers, the latest Consumer Price Index data suggests.
That is odd for an economy with a tight labor market, with unemployment running at a 3.8 percent. And some analysts say it is a reason for officials to slow their pace of rate increases, since the benefits of a hot economy have not yet translated into a significant wage increase for workers.
At a comparable time of low unemployment, in 2000, “wages were growing at near 4 percent year over year and the Fed’s preferred measure of inflation was 2.5 percent,” both above today’s levels, Tara Sinclair, a senior fellow at the Indeed Hiring Lab, said in a research note. “Too many increases too quickly could choke the economy before we really see how good it could get.”
Powell played down concerns about slow wage growth, acknowledging it is “a bit of a puzzle” but suggesting that it would normalize as the economy continued to strengthen.
The Fed chairman said growth was being lifted, at least in the short term, by tax cuts and government spending increases signed into law by President Donald Trump last year. And he dismissed, for now, concerns that Trump’s trade policies, including tariffs on steel and aluminum imports, were hurting growth, saying the Fed had yet to see any data indicating an impact.
“So right now, we don’t see that in the numbers at all. The economy is very strong, the labor market is strong, growth is strong,” he said, adding, “I would put it down as more of a risk.”
In a statement released at the end of the meeting, Fed officials noted that economic activity had been rising “at a solid rate” — a change from their May statement, when they called the rate “moderate.” Fed officials now expect the economy to grow at a 2.8 percent rate this year, up from a 2.7 percent forecast in March. The unemployment rate is now projected to fall to 3.6 percent by year’s end, down from a forecast of 3.8 percent in March.
“The changes from the Fed today should not come as a surprise, given recent economic developments, but they nonetheless signal a more hawkish outlook for the next few quarters,” Eric Winograd, a senior economist at AllianceBernstein, said in a research note.
The Fed now faces a tricky balancing act as it tries to calibrate how to keep the economy chugging along. Raising rates too quickly could snuff out the economic recovery, which has finally begun to gain steam after years of sluggish growth. But not raising rates fast enough could allow inflation to spiral out of control, driving up prices and potentially plunging the economy back into a recession.
A few Fed officials have raised concerns that the inflation trend could accelerate rapidly, forcing the Fed to raise rates faster than expected to keep the economy from overheating. They appeared to have won a convert in Wednesday’s projections, which now show that a majority of officials expect rates to rise to a range of 2.25 to 2.5 percent by the end of this year.
Officials continue to project three additional increases in 2019, but reduced the number of forecast increases for 2020 from two to one.
A faster pace of rate increases could slow economic growth, potentially frustrating Trump. But Fed officials signaled a willingness to allow inflation to remain slightly above their 2 percent target for several years — which would be accommodative for growth. Officials raised their headline inflation rate forecast for the year as well, to 2.1 percent from 1.9 percent. The Fed now predicts inflation will run slightly above its target rate of 2 percent through 2020, at 2.1 percent each year, a slight overshoot that Fed officials have roundly indicated they are comfortable with, in part because of slow wage growth.
Financial markets had been widely expecting the Fed to raise the benchmark rate, and the reaction among investors was muted, even as the official monetary policy statement struck some as signaling growing confidence that rate increases would continue, and might even proceed at a faster pace.
The stock market, which had been modestly positive for most of the day, turned slightly negative after the rate decision was announced at 2 p.m. Short-term Treasury bond yields, closely tied to monetary policy, rose faster than yields on longer-term bonds which take their cues from forecasts for economic growth and inflation, suggesting that investors in the bond market see economic growth continuing but not picking up sharply. It was the second news conference for Powell, who succeeded Janet L. Yellen in the job this year. But this was the meeting where Powell made several clear breaks from his predecessors, in a series of changes around process and communication that could ultimately have big implications for monetary policy and the economy.
He began his session with the news media with what he called a “plain English” description of what the Fed had done and why, a contrast with the practice of Yellen and her predecessor, Ben S. Bernanke, both Ph.D. economists who prefaced their appearances with long prepared statement loaded with monetary policy jargon.
And he stood before reporters, in contrast to Yellen and Bernanke, who both chose to sit at a desk for their post-meeting news conferences.
Powell announced that he would begin holding a news conference after every Fed policy meeting starting in January; currently such a session is held only after four of eight annual meetings.
While he insisted that this was not meant to signal any change in the direction of policy, it opens up more flexibility for the Fed as it sets interest rate policies. Financial markets currently expect interest rate increases only in meetings with a news conference; now the Fed will have the option of making more than four policy moves a year without unnecessarily surprising markets.
“The June communication really ushered in the Powell Fed,” said Julia Coronado, an economist and president of MacroPolicy Perspectives. “He stood at a lectern instead of sitting at a desk, he is moving toward more frequent communication, and the communication style from the statement to the press conference is direct and pragmatic.”
And the Federal Open Market Committee, which Powell leads, changed its statement describing its rate increase in a way that removed a mainstay of its monetary policy of recent years. Dating to the Bernanke era, the Fed has used “forward guidance” to signal the future direction of interest rates.
For example, at the March policy meeting, the committee said its interest rate target was “likely to remain, for some time, below levels that are expected to prevail in the longer run.” That language was excised from the policy statement released on Wednesday, saying only that the “timing and size” of future rate increases will be determined by many factors.