For 2016 we see an even more spread out distribution than 2014 or 2015. One voter is calling for 0.75 percent, while another is calling for 4.25 percent. The other 14 participants are sprinkled in a range in between. If we assume that the most hawkish participants remain hawkish between 2015 and 2016, and the doves remain doves, then the pace of tightening could be a bit slower than what is expected in 2015.
We only see opinions begin to converge when looking at the “longer run” estimate. This is a narrow range of 3.5 to 4.25 percent, and represents the market equilibrium federal funds rate that should be in place when the economy is in balance. So there is relative alignment on where we are going, it’s the path and speed that are so different.
Personally, I like to think of the federal funds rate as a gas pedal. The “longer run” rate represents the amount of stimulus, or fuel, necessary to keep the economy growing at the same rate. Lower rates represent stimulus to the economy, a pressing of the gas pedal. Higher rates represent slowing down, either by taking the foot off the gas or hitting the brake. Thinking about policy in this framework helps to explain the Fed’s movements. When we do start to move from the current level of rates up to 25 bps it will not initially represent slowing down the economy, but rather providing less gas and growth by easing off the pedal. It is only when we breach the longer run level of around 4% that the Fed really begins to apply the brakes. And that is likely a few years off.
So what does this mean for investors? I think that there are 3 important things to keep in mind:
- Remember that there is a wide range of opinion within the Fed. The average is important, but watch the participant rate range to get a sense for how much uncertainty there may be in future policy.
- Only 3 of the FOMC participants expect that we will reach the “longer run” range by the end of 2016. As a result, it is likely that the Fed will still be in tightening mode into 2017.
- Think of the federal funds rate as a gas pedal. Sometimes it makes sense to ease up a bit, if only to accelerate less quickly. Unless the Fed stomps on the brakes and brings the federal funds rate above the “longer run” policy rate, then what we are really talking about is just a range of acceleration.
Matt Tucker, CFA, is the iShares Head of Fixed Income Strategy and a regular contributor to The Blog. You can find more of his posts here.