Janet Yellen, chair of the U.S. Federal Reserve Bloomberg News
“Don’t fight the Fed” is the decades-old mantra for the markets. It’s the Fed that’s actually been fighting the markets, but it has had to cede ground steadily.
As universally expected, the Federal Open Market Committee held its federal-funds rate target unchanged, at 0.25-0.5%, after its two-day meeting concluding Wednesday. The vote this time was unanimous as Kansas City Fed President Esther George did not dissent in favor of a quarter-point rate hike as she did at the April meeting.
But more importantly, the FOMC rolled back its expectations for future increases in its key policy rate, both for the remainder of 2016 as well as in the coming two years and beyond.
For this year, the so-called Dot Plot of the expectations of the committee’s members—both voting and non-voting—showed an unchanged median year-end forecast for the funds rate target at 0.875%, which would imply two quarter-point increases. But the dispersion of the dots was broader and lower than at the previous forecast at the March 16 meeting.

At this week’s confab, there were seven projections for two increases, to 0.875%, and six for a single hike, to 0.625%. There also were two outliers expecting more hikes to above 1%. Excluding the highest and lowest guesses, the “central tendency” was in a range of 0.6-0.9%, according to the Fed’s projections (which are available at www.federalreserve.gov).
In March, however, there was a solid consensus of nine members’ expecting two hikes to 0.875%, and seven looking for more hikes to over 1%. Back then, the single outlier was calling for just one increase to 0.625%. The central tendency also was significantly higher three months ago, at 0.9-1.4%. Again, all with an unchanged median year-end projection.
The fed-funds futures market wasn’t fooled and saw clearly the downshift in FOMC rate expectations. For its part, the market had only put even money (a 48% probability, to be exact) on even a single rate hike by December prior to the announcement of the FOMC’s decision, based on Bloomberg’s data. By the 3 p.m. EDT settlement and after the release of the Fed’s decision and outlook, the odds were roughly three-to-two (41% probability) against any increase at all in 2016.
As for subsequent years, the FOMC’s median dot plot for the end of 2017 moved down to 1.6% from 1.9%. A perusal of the distribution showed a mode (the most frequently occurring data point) actually was 1.375%, down a hefty half percentage point from 1.875% in March.
The same pattern was evident for end-2018. The median dot plot dropped quite sharply, to 2.4% from 3%. And distribution put nine dots clustered at either 2.125% or 2.375%, with six spread out above.
Again, the center of gravity for two-and-a-half years out moved down significantly.
Finally, the FOMC’s estimate of the long-run equilibrium fed funds rate declined as well, to a median of 3% from 3.3%. What’s more, that median guesstimate is down from about 3.75% a year ago. (I’m also old enough to recall that 3% was the cyclical trough for the fed funds rate back in 1992, which seemed an unbelievably low rate at the time.)
In her post-meeting press conference, Fed Chair Janet Yellen acknowledged the market’s longer-run rate expectations are low, which she attributed in part to weak productivity and household formations but are global phenomena. Those factors would tend to limit the potential growth of the economy, which would tend to mean lower interest rates.
But, while the Fed remains committed to “normalizing” rates, MKM Partners chief economist and strategist Michael Darda says what the market knows (and what the financial press doesn’t understand) is that the equilibrium interest rate remains depressed. (He uses the definition from free-market economist Knut Wicksell, who defined neutral over a century ago as the rate that is associated with stable prices.)
The end of quantitative easing was a de facto tightening by the Fed, which has brought the funds rate up to what Darda estimates as the equilibrium rate (using his model based on the ratio of employment to the working-age population and a risk premium). That would make a rate hike a mistake, especially given the rise of business-loan delinquencies, which he finds to be a leading indicator of an upturn in the unemployment rate.
As a card-carrying member of the financial press, there’s a lot I don’t pretend to understand. What I can observe is that the Fed has had to backtrack repeatedly on its expectations for interest-rate increases.
In addition, long-term bond yields continue their relentless retreat around the globe. The 10-year U.S. Treasury ended Wednesday under 1.60%, less than a quarter-point from its record low. Even as the U.K. prepares to vote on Brexit, 10-year gilts hover near their all-time lows at 1.12%. German and Japanese 10-year yields are below zero with the help from QE asset purchases by their respective central banks.
And while Yellen reasserted the Fed’s next move depends on the economic data, I would also observe last December’s hike came while the stock market was on the upswing and the Standard & Poor’s 500 was within a few percent of its 2132 record. The FOMC opted not to follow up with a second hike at the March meeting, when global risk markets were climbing off the mat from the drubbing they took in January and early February.
And while the dreadful May employment report and next week’s Brexit vote likely would have precluded any move this week, it will be interesting later in the year to see if Yellen & Co. raises rates if the S&P 500 continues to founder under the 2100 mark. Fed funds futures say it’s not happening this year, and the market has been more on target than the Fed.