Analyst’s Insight: Fed funds hike – do old pipes really give the sweetest smoke?

On Wednesday June 14th, the Federal Reserve (Fed) has raised short-term interest rates for only the fourth time in more than 10 years (i.e., since the global financial crisis) and for the second time in 2017, stepping up the pace of tightening while inflation expectations are moving in the opposite direction that the Fed wants them to move. The Fed raised the target range for the federal funds rate by 25 bps, now between 1% to 1.25% and “continue to feel that with a strong labor market and with a labor market that is continuing to strengthen, the conditions are in place for inflation to move up,” as Janet Yellen said during the press conference that followed the FOMC decision.

Yellen is pressing ahead with plans to normalize monetary policy, betting that the ongoing strength of the labor market will ultimately prevail over the recent weakness in inflation. Indeed, the Fed’s favorite price gauge (PCE deflator) stood at 1.7% YoY in April, down from 1.9% in March and 2.1% in February. And it probably took another leg down in May, based on different consumer price data released on Wednesday June 14th. “It’s important not to overreact to a few readings, and data on inflation can be noisy,” Yellen recalled to reporters. She attributed much of the recent weakness to “one-off” factors such as a steep decline in mobile phone costs and a drop in prescription drug prices, but investors don’t seem to be buying that explanation as inflation expectations are moving in the opposite direction that the Fed wants them to move.

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