Fed leaves rates unchanged; signals further hikes

The Federal Reserve has left interest rates unchanged while signalling that it expects a resilient US economy and solid job market to justify further rate hikes later this year.

The Fed’s pause comes after it modestly raised its benchmark short-term rate in December and March. Most economists expect it to do so again when it next meets in mid-June.

The statement the Fed issued today after its latest policy meeting notes that the economy slowed during the January-March quarter but says it expects that slowdown to be “transitory.”

Nearly eight years after the Great Recession ended, unemployment is at a low 4.5 per cent. Key sectors of the economy appear sturdy. Still, consumer spending and factory output have slowed, and inflation remains below the Fed’s target rate.

The Fed remains in the midst of a campaign to gradually raise interest rates from ultra-lows. One reason for it to stand pat this week is that even though the job market has shown steady strength, the economy itself is still growing in fits and starts.

On Friday, the government estimated that the economy, as gauged by the gross domestic product, grew at a tepid 0.7 per cent annual rate in the January-March quarter. It was the poorest quarterly performance in three years.

Though some temporary factors probably held back growth last quarter and might have overstated the weakness, the poor showing underscored that key pockets of the economy consumer spending and manufacturing, for example remain sluggish.

On Monday, the government said consumer spending stalled in March for a second straight month. And the Institute for Supply Management reported a drop in factory activity.

Most economists have expressed optimism that the economy is strengthening in the current April-June quarter, fuelled by job growth, higher consumer confidence and stock-market records.

Many think that annualised growth could accelerate to around 3 per cent and that the Fed will soon feel confident to resume raising rates. The global economic picture has also brightened somewhat.

It isn’t just the Fed’s short-term rate a benchmark for other borrowing costs throughout the economy that likely occupied attention at this week’s meeting. Officials probably also discussed how and when to start paring their extraordinary large USD 4.5 trillion portfolio of Treasurys and mortgage bonds.

The Fed amassed its portfolio commonly called its balance sheet in the years after the financial crisis erupted in 2008, when it bought long-term bonds to help keep mortgage and other borrowing rates low and support a frail economy.

At the time, the Fed had already cut its short-term rate to a record low. The balance sheet is now about five times its size before the financial crisis hit. The Fed stopped buying new bonds in 2014 but has kept its balance sheet high by reinvesting the proceeds of maturing bonds.

The Fed’s thinking has been that reducing the balance sheet could send long-term rates up and work against its goals of fortifying the economy.

Now, as the Fed becomes more watchful about inflation pressures, the time is nearing when it will need to shrink its balance sheet, a process that could have the effect of raising some borrowing rates, at least modestly.

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