Federal Reserve leaves rates on hold, citing downside to growth from global and financial developments

In a close and much anticipated decision, the Federal Open Market Committee (FOMC) left the fed funds rate at its current target range of 0 to ¼ percent. All other aspects of monetary policy including the reinvestment of principal payments and rolling over of Treasury securities also remained in place. The FOMC's decision to leave rates on hold was prefaced by noting that "recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."

The deterioration in the economic outlook was also recognized in downward revisions to the summary of economic projections (SEP). While the projection for real GDP growth in 2015 came up due to better historical data (to a median of 2.1 from 1.9 previously), the median projection for 2016 was revised down to 2.3 (from 2.5). The projection for 2017 growth was unchanged, while the newly added 2018 matched the long run projection (also unchanged) of 2.0%. Expectations for inflation were also revised down, albeit modestly, through 2016 with the median estimates coming down 0.1 percentage points on both core and headline PCE price indexes.

In what has become a recurring pattern, the Fed lowered its expectations for near-term unemployment, but also its judgment of where it will converge to in the long run. The median projection for the unemployment rate at the end of 2015 fell to 5.0 (from 5.3), while the projection for the rate from 2016 and 2017 fell to 4.8 (from 5.1 and 5.0 respectively). It remained at 4.8 in 2018, before being expected to converge to 4.9 (down from a previous longer run estimate of 5.0).

The "dot plot" of FOMC member's expectations for future interest rates showed a slight movement downward through all the years and the long run. The addition of 2018 to the projections also shows that the Fed does not see policy returning fully to normal until at least the end of the projection period. For 2015, the median dot fell to 0.375 (from 0.675), suggesting one rate hike this year instead of two. For 2016, the median dot also fell 30 basis points to 1.375 (from 1.675), indicating that members still see 100 basis points of tightening through the year. The same pattern held through 2017 with members seeing 125 basis points in tightening, but the lower starting point bringing the median projection to 2.625. The new 2018 median dot plot came in at 3.375, ever so slightly below the now lower long run median projection of 3.5.

The waiting game continues. With the formal recognition of the downside threat to growth from global developments, this was a relatively dovish statement. It seems unlikely that the recent volatility in financial markets or news from emerging markets will substantially turn the corner before the next meeting at the end of October. This means that if a rate hike is to occur this year - as the majority of FOMC members still expect - it will take place in December.

The downward adjustment to the longer run projection for unemployment implies the bar for "some improvement in the labor market" has been raised slightly. Still, the fact that the SEP's projections for the unemployment rate fall below the long run expectation even while inflation remains under target, means that the Fed sees more slack in the labor market than the official rate indicates.