The Fed's decision to wait on raising rates, and the reduction of their longer term rate projections, is another sign that the central bank is fighting an uphill battle against structural impediments to U.S. growth.
Jeremy Glaser: For Morningstar, I'm Jeremy Glaser. The Fed stood pat on interest rates, which was expected. But I'm here with Bob Johnson, our director of economic analysis, to see if anything else the Fed said today impacts his thinking on where interest rates are going.
Bob, thanks for joining me today.
Bob Johnson: Great to be here today.
Glaser: So, after that pretty dismal jobs report no one expected the Fed to move in this meeting. But we did get some new projections; we got some new information. Do we see any signs that the Fed is just going to take a pause; we really could see increase in July or September; or are we going to see rates stay this low for quite some time after this jobs report?
Johnson: Well, if you look mathematically at the data, they really did still keep the average projection--or I should say the median projection for the year the same, kind ofbetween 0.75% and 1% for the Fed funds rate. So, that's their thinking by the end of the year. That's what it was at the March meeting. However, the mix of governors they thought that that's what it would be changed. So, the meeting was still the same, but how the individuals shifted a little bit certainly indicated they were taking a somewhat more conservative stand to the year. But they are still expecting on average--or on median to get two more rate hikes yet this year. So, it's certainly not off the table.
Glaser: But they also updated some of their other projections, including for inflation that went up. How do you square? We think inflation is going to get higher but we also are sticking with our expectations on rates.
Johnson: Yeah. I think what they did on rates was just to be careful, if you will, because of the labor market report. I mean, they said--they actually acknowledged that particular report in the data and I think that that was really their big worry. They just can't take a chance. I mean, that piece of data, that May jobs report, seemed to be a bit of an outlier even relative to other employment data and certainly, relative to, say, this week's retail sales reports and everything that say that the economy is in decent shape. So, certainly, there were a lot of questions about that report. But nevertheless, they can't take a chance and so they indicated one of the reasons why they paused along with maybe potentially the Brexit situation, both caused them to at least temporarily pause. But on the other hand, they didn't seem to be like racing to raise their numbers higher either.
Glaser: And what about their estimates for growth?
Johnson: Well, they do their economic forecasts four times a year to kind of go with these meetings. And they did bring in their GDP growth estimate from this year from 2.2% to 2%, which is about in line with what we are thinking here. They brought in the number for 2017 from 2.1% to 2% and kept both the 2018 and the longer term GDP growth rate at about 2%. So, that was relatively--I mean, it was certainly, they brought down growth, but on the other hand, they did bring up their inflation forecasts as you mentioned.
Glaser: So, we spend a lot of time talking about the Fed. The markets obviously are very focused on the Fed. But the focus has kind of misplaced. Do you think that the Fed really is either kind of the solution or the problem to what's happening to the economy right now, or just an easy place to look at?
Johnson: Well, they certainly seem to be an easy scapegoat for problems and oh, really, uncertainty of the Fed and so forth. But I think the real issue is that demographics are beginning to hit hard, and there isn't much that the Fed can do to change the numbers or anybody because the die is cast with birth rates, say, 20 to 40 years ago and that's what's moving the data sets around and that's why we've got slower growth. We've got much slower world population growth, slower growth here in the United States and it's not only slower growth but that population is aging and that means they may not be in the workforce anymore and can't contribute to GDP growth anymore. And it means as you get older, you tend to spend differently and less and, all of those things are weighing on GDP and not just here but around the world and those are things that are holding back the growth rate. And it's not the fact that interest rates are sky high and it's not that interest rates are going to cure the problem.
Glaser: With those demographic trends then, could the natural interest rate then be much lower than it's been in the past? Maybe there isn't that much room for the Fed to raise rates because we're not that far away from where rates should be?
Johnson: Yes, I think, that's absolutely true and certainly, their projections kind of acknowledged that. I mean, the longer term Fed funds rate, which they thought might grow to 3.25%, they now think it will be more like 3% and that's down from even much higher numbers a year or two ago. So, they've continually brought that in and that's the Fed funds rate and that obviously has two components to it; whatever we think inflation is going to be in addition to whatever we think the real interest rates should be. And one of the things that real interest rates represent and what they help project is what we think the real economic growth rate is and the lower your long-term growth rate is, the lower your real interest rate should be as well.
Glaser: Bob, as always, thank you for your analysis.
Johnson: Thank you.
Glaser: For Morningstar, I'm Jeremy Glaser. Thanks for watching.
