Are U.S. Interest Rates Going to Continue to Rise?

Those who watch Federal Reserve interest rate movements closely are often read a lot into the press releases issued by the Fed. Whenever the Fed makes a decision on the Federal Funds rate, they issue a press release such as this one, which was released on May 10th, 2006:

The Federal Open Market Committee decided today to raise its target for the federal funds rate by 25 basis points to 5 percent.

Economic growth has been quite strong so far this year. The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

As yet, the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation, ongoing productivity gains have helped to hold the growth of unit labor costs in check, and inflation expectations remain contained. Still, possible increases in resource utilization, in combination with the elevated prices of energy and other commodities, have the potential to add to inflation pressures.

The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information. In any event, the Committee will respond to changes in economic prospects as needed to support the attainment of its objectives.

In these releases, there's always a couple of sentences which are key in predicting what the Fed has in mind for interest rates. In the last one, the sentences were:

The Committee judges that some further policy firming may yet be needed to address inflation risks but emphasizes that the extent and timing of any such firming will depend importantly on the evolution of the economic outlook as implied by incoming information.

As I wrote when the statement was released, this wording is fairly non-commital. It suggests the interest rates may continue to rise, but the next rate hike may not be until sometime well into the future.

It's interesting to comapre this to the previous press release, which was issued on March 28, 2006. In that one, the rate was raised to 4 3/4 and in hindsight we know that the rate would be increase during the next release. The key passage of that release read:

The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives.

Note that this release uses the same some further policy firming may be needed language, but does not say anything about the possible timing of such firming.

Let's consider the key sentences in the three previous press releases before those. Keep in mind that a rate hike immediately followed each release.

January 31, 2006: "The Committee judges that some further policy firming may be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives."

December 13, 2005: "The Committee judges that some further measured policy firming is likely to be needed to keep the risks to the attainment of both sustainable economic growth and price stability roughly in balance. In any event, the Committee will respond to changes in economic prospects as needed to foster these objectives."

November 1, 2005: "With underlying inflation expected to be contained, the Committee believes that policy accommodation can be removed at a pace that is likely to be measured. Nonetheless, the Committee will respond to changes in economic prospects as needed to fulfill its obligation to maintain price stability."

I would have guessed that "policy accommodation can be removed at a pace that is likely to be measured" would have meant that rate hikes were coming to an end, but we know that rate hikes continued to follow immediately afterwards.

It's interesting to note how the certainty of a rate hike has decreased in the last four press releases. First policy firming was "likely to be needed", then we had two consecutive "may be needed", and finally a "may be needed" with the qualifier on the timing of such a hike.

What does this all mean? It appears that rates will continue to rise, but at a much slower rate. Does it mean we'll have our first release without a rate hike in the last few years? Only time will tell.

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