Rick Rieder, Chief Investment Officer of Fundamental Fixed Income at BlackRock and co-manager of the BlackRock Fixed Income Global Opportunities Fund (FIGO), provides the below comments on yesterday’s Fed policy statement.
- Yesterday’s FOMC statement leaves the door ajar for the Fed to begin its normalization of policy rates before year end, as the Fed clearly recognizes the improvements to labor markets, while inflation and wages have remained subdued.
- We expect wage growth to pick up alongside payrolls, and this Friday’s Employment Cost Index data should provide a window into Fed lift-off timing.
- Regardless of whether the Fed begins to lift-off the zero bound in September or a bit later, the more important message from the central bank, which has been unambiguously clear, is that the path of rate change will be gradual and the long-run terminal rate lower than in the past.
The Federal Reserve’s Federal Open Market Committee laid out a statement that while in line with prior announcements increasingly recognizes that recent labor market improvement, and inflation and its expectations, signal the economy is ready for an initial lift-off of policy rates before year end. We still believe that the FOMC’s September meeting is the most likely date for this lift-off (with December a real possibility too), but we would argue that the precise timing of the event is much less important than the pace of policy rate change, as well as the ultimate destination of the terminal rate.
And in terms of pace and destination, the Fed has been unambiguously clear that the path of rate change will be gradual and the long-run terminal rate lower than the 4.25% that was previously considered the norm. Indeed, in her recent Humphrey-Hawkins testimony, FOMC Chair Yellen repeatedly used the term gradual to describe the trajectory of policy rates. In the FOMC’s statement, this tone was reinforced by a quite positive assessment of labor market gains, with the recognition that inflation is still running low and export activity has been soft.
In terms of the timing of lift-off, it is clear to us that the Committee’s current composition is historically dovish and it will hold a high bar to each change in rates, particularly the first. So despite the fact that our proprietary “Yellen Index” of labor market indicators (as they relate to the Fed’s reaction function) unquestionably implies the readiness of the economy to handle a rate increase, the dovish interpretation of selected data may keep the Fed on hold longer than we would anticipate, particularly with a benign inflation environment and subdued wage growth to date.