When Janet Yellen and her Federal Reserve colleagues announce their monetary policy decision this week, investors will be looking closely for one phrase: “Nearly balanced.”
If the Fed says at the conclusion of its two-day meeting on Wednesday that the risks to the economy are “nearly balanced” or just “balanced,” that will be taken as a sign that the worries about a recession that took hold earlier this year have mostly abated, and that the Fed sees a clear path for raising interest rates later in the year.
“If we do see a shift in language back to more along the lines of ‘balanced risks,’ I think most people would interpret that, I would certainly, as a signal that rate increases are a real possibility for later in the spring and especially the summer,” said Peter Ireland, a professor of economics at Boston College with experience in the Federal Reserve system.
That would be a shift from earlier in the year, when stock market plunges and the threat of economic fallout from China convinced many economists and investors that the Fed would not raise rates at all in 2016, after a historic 0.25 percent increase in the interest rate target in December.
In their January statement, the Fed members removed a passage stating that the risks to the economy were “balanced,” hinting that they saw the risks as tilted toward a recession.
Now, bond futures prices suggest that there is about a 25 percent chance the Fed may raise rates at its next meeting in April, and a 50 percent chance it will do so in June. In other words, investors see it as a possibility that the Fed may raise short-term interest rates all the way to 1 percent by the November elections.
Such rate hikes are necessary, in the view of some Fed members, because with job growth strong throughout the winter, inflation would be expected to pick up in future months. If the Fed doesn’t act relatively soon, inflation could rise above the Fed’s 2 percent target.
In a speech last week, Fed vice chairman Stanley Fischer suggested that he was seeing the “first stirrings” of rising inflation, with consumer prices, setting aside food and shelter, up 1.7 percent, not too far from the Fed’s target.
Other members of the Fed committee, however, appear to be less worried about the Fed falling behind inflation trends and more worried that jobs growth won’t translate into higher inflation and an economy operating at full capacity. In an appearance last week, Fed governor Lael Brainard suggested that the Fed should wait for clear confirmation of inflation rising, in part because there are still risks to the U.S. economy, especially in the possibility of a China slowdown.
Whether such risks will translate into turmoil in U.S. markets, making it harder for businesses and individuals to get loans, create businesses, and so forth, “becomes really kind of a judgmental call” for the Fed this week, said Keith Hembre, chief economist for Nuveen Asset Management.
Even so, added Hembre, the Fed has weathered the most worrying signs of market volatility and recession risk, and is likely to be able to tighten money in the months ahead. “My anticipation would be that if the incoming data continue to move in the direction that they have been lately,” he said, “not only is June more likely than not, but you could potentially even see it in April.”
