Although there was no drama in the Federal Reserve’s decision today to remove 25 basis points of accommodation (also known as a policy rate hike), there was a surprising – and laudable – amount of substance in the changes to the accompanying Fed statement. This is a Fed that likes to say it’s data-dependent, but as we’ve written, data dependence by itself is not a monetary policy. Today’s statement goes some way in laying out what the monetary policy goal is and – via the “dot plot” – what the path to a neutral policy rate may look like.
First and foremost, the normalization path implied by the median dot is unchanged from the previous projection in December 2016: three hikes (including today) in the fed funds rate in 2017 and three hikes in 2018. What’s also important is that in today’s statement the Fed added new language that this liftoff path is expected to be consistent with inflation that will “stabilize” and be “sustained” and “symmetric” around the Fed’s 2% target. (Recall that the Fed’s preferred measure of U.S. inflation is Personal Consumption Expenditures, or PCE. The more widely quoted Consumer Price Index was 2.2% as of the end of February 2017 for annualized core inflation.)
Until today, Fed statements and comments from key officials had been preoccupied with risk management. With today’s interest rate hike and confirmation of a gradual but regular pace of hikes, the Fed is conveying a level of confidence in the economy as well as reinforcing that the 2% inflation target is symmetric – that is, inflation overshoots are neither more nor less tolerable than undershoots.
Of course, little is known about the ultimate shift in U.S. fiscal policy that is likely to take place under the Trump administration, but the Fed is saying today that even before the potential fiscal boost is factored in, the U.S. economy no longer requires emergency policy rates.
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Richard Clarida is PIMCO’s global strategic advisor and a frequent contributor to the PIMCO Blog.