Janet Yellen, chair of the U.S. Federal Reserve (Photographer: Andrew Harrer/Bloomberg)

Fed Unmoved by Soft Patch Hardens Conviction on Rate-Hike Plan

(Bloomberg) -- Don’t bet on the Federal Reserve blinking again.

U.S. central bankers appear to be on course to raise interest rates twice more this year and remain confident in their forecast for growth of around 2 percent despite a series of weak first-quarter reports.

That’s a shift from past performance, when they backed away from projected rate increases in the face of unexpected headwinds. Now, the bar for delay is higher.

“I still think the median of three rate increases for this year -- we’ve already done one -- is still a good baseline,” Dallas Fed President Robert Kaplan, who votes on policy this year, told Bloomberg Television’s Michael McKee in an interview Thursday. “If the economy develops a little more slowly then we can do less than that, if the economy is a little stronger we can do more.”

Investors are betting on just one more increase in 2017, according to the prices of futures contracts linked to the benchmark overnight rate. The perceived chances of the Fed doing more than that this year were quickly reduced after President Donald Trump said in an April 12 interview that he favored low rates. Then, an April 14 Labor Department report revealed that a closely watched measure of U.S. inflation unexpectedly fell for the first time in seven years. Increasing geopolitical tensions haven’t helped either.

Investors have grounds for skepticism. Fed officials forecast four hikes in 2015 at the time of their December 2014 meeting but only moved once, and then repeated the same pattern the following year: projecting four moves in 2016 and only delivering one.

Fed Unmoved by Soft Patch Hardens Conviction on Rate-Hike Plan

This time, policy makers aren’t backing down.

“It is appropriate to continue to be raising the short-term federal funds rate,” Boston Fed President Eric Rosengren said on Wednesday. “The economy is strong enough to sustain that right now, even though I’d say that the recent data has been a little softer than I was expecting.”

Comments like this suggest it will take a protracted pattern of weakness to bump Fed officials off the shift they made this year toward a faster pace of rate hikes. Underlying that view is the sense that leaving rates too low for too long is also risky with unemployment already subdued at 4.5 percent and inflation around the central bank’s 2 percent target. On top of that, upside risks to their current forecasts for the economy outweigh downside risks.

Bias to Hike

“You need a substantive weakening to cause them to delay,” said Michael Gapen, chief U.S. economist at Barclays Plc in New York. “The bias has been to move, whereas previously the bias had been toward inaction.”

Nevertheless, the string of weak reports is stirring.

-- Inflation stepped backed in March, the first decline in the consumer price index in 13 months. Service prices fell 0.1 percent, the most since 2010, and overall core prices, a measure without food and energy, fell by the most since 1982.

-- Retail sales were down 0.2 percent last month after a 0.3 percent drop in February.

-- March was the slowest month for U.S. auto sales in two years.

-- Consumer inflation expectations fell in March after advancing in the previous four months, according to a New York Fed survey. Break-even inflation rates as measured by yields on inflation-protected Treasury securities have dropped to the lowest levels since mid-November.

-- Commercial and industrial bank loans fell at an 8.4 percent seasonally adjusted annual rate in March after a 1.3 percent decline in February.

-- Non-farm payroll gains last month slowed to 98,000 from 219,000 in February.

Mixed Picture

Fed officials typically look at a broad palette of information and a month or two of weakness isn’t enough to describe a pattern.

For example, payrolls are rising at 178,000 jobs a month when averaged over three months.

The CPI was influenced by what could be one-time effects: prices of mobile phone service slumped a record 7 percent, while the cost of lodging away from home fell 2.4 percent.

Indeed, Fed Chair Janet Yellen called the economy “pretty healthy” in an April 10 speech and said she expects it will “continue to grow at a moderate pace.”

The outlook for global growth has also improved. The International Monetary Fund this week forecast that global growth will pick up to 3.5 percent this year and 3.6 percent in 2018 from 3.1 percent in 2016.

That makes policy makers more confident the global economy can withstand higher U.S. interest rates.

“Foreign output expansions appear more entrenched,” Fed Vice Chairman Stanley Fischer said Wednesday, with “downside risks to those economies noticeably smaller than in recent years.”

The Fed panel that decides on interest rates next meets May 2-3, and futures traders see the chances of a hike then as slim to none.

A key piece of data -- gross domestic product for the first quarter -- will be released on April 28. The Atlanta Fed’s GDPNow gauge earlier this week showed growth from January through March tracking at a 0.5 percent pace.

Fed officials have five more 2017 meetings after the May gathering, giving them plenty of time to wait and see if their forecast for a rebound in the economy pans out.

“We have the ability and the flexibility to wait and see how the economy unfolds, turn over a few more cards, and I would counsel that that’s quite appropriate; that we exercise that patience,” Kaplan said.