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Another Baby Step Toward Liftoff

| June 18, 2015
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The Federal Open Market Committee (FOMC) upgraded its assessment of the U.S. economy in its policy statement but signaled it is still waiting for more evidence that inflation will move toward its 2% target. There were tweaks to the economic projections but nothing dramatic. 

As for the timing and pace of rate hikes, some people like to look at the midpoint of the dot-plots to get a feel for hiking dynamics. The dot-plot shows where, at the end of the calendar year, the 17 participants (12 Federal Reserve presidents and 5 Federal Reserve board members) think the federal funds rate target may be. Because policy is set by a majority vote, the logic is that the midpoint is where the federal funds target will be. That’s a mistake.

There are only 10 voting members, not 17. Not every dot is equal. Now, we don’t know whose dot is whose, but we can tell that people like Charles Evan (a voting member this year) is more dovish than, say, Jeffrey Lacker (also a voter). But it’s not all 10 that need to agree. Only a majority need to agree. I think it’s reasonable to look at the bottom six dots (Kocherlakota is very dovish, but he’s not a voter this year; plus, he’s retiring). On that basis, we could have one hike this year and then four next year. These dots probably paint a picture of a hike in October or December and then hikes at every other meeting. That would fit the plots, but the plots can change.

Another trajectory that could fit is one where they move the midpoint of their target range from the current 12.5 basis points (bps; 100 bps equals 1.00%) to a midpoint of 25.0 bps. A meager hike in July would not be unreasonable if the labor market continues to improve, oil prices stay about where they are, and the dollar’s value in the foreign exchange market stabilizes. So the Fed could do a 12.5-bp hike in July, another 12.5-bp hike in October, and then move in 25.0-bp increments at every other meeting or as appropriate. That would be a stutter-step start, which may be the right way to get going.

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