Fed Ready to Raise Rates in June

The Federal Open Market Committee (FOMC) held rates steady at the May meeting while affirming the intention to raise short-term interest rates in June. The statement issued after the meeting indicated that FOMC members are convinced that inflation is finally firming in areas beyond the volatile food and energy sectors. Service sector inflation, which is the most sensitive to strong domestic demand and wage increases, is rising.

The statement affirmed the committee members’ commitment to symmetry in the inflation mandate, which means they expect to overshoot on their 2% inflation target to make up for systemically low inflation earlier in the cycle. We expect to see the minutes to the May meeting reveal shifts in how the Federal Reserve wants to frame its inflation target. President John Williams of the San Francisco Fed, who will soon take over at the New York Fed, has advocated to shift the focus from short-term percentage changes in prices to the overall index level; this is called price-level targeting and would allow the FOMC more flexibility in managing the inflation trajectory.

We are in for a flurry of speeches by Fed leaders in the next week. Most of those will come from officials who tend to favor more rate increases. They are expected to argue for four instead of three rate hikes for the year - three more - which will pave the way for a move up in the Fed’s trajectory for rate hikes at the June meeting.

Support is growing within the Fed system to hold a press conference after every meeting. That would allow the new chairman, Jay Powell, to better convey what the members are currently thinking and open the door to more flexibility on rate hikes. The key will be to signal to financial markets that regular press conferences do not imply a more aggressive path on rate hikes.

Bottom Line
The Federal Reserve is regaining credibility for its forecasts. Inflation is firming at the same time that labor markets are tightening. This allows for more latitude in raising rates. However, the FOMC will remain cautious and try to keep the pace of rate hikes gradual for fear of inadvertently disrupting the financial markets.

About the author
Diane Swonk Diane Swonk
Chief economist
Twitter: @DianeSwonk

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