The Federal Reserve left its benchmark interest rate unchanged on Wednesday, amid enduring uncertainties about where the tax cuts, infrastructure spending and other proposals of the Trump administration could take the economy in the near future.
However, the Fed’s carefully worded statement hinted that expectations for economic growth and inflation are strengthening, as consumer and business sentiment improves and oil prices rebound from ultra-low levels in recent months.
Analysts had widely expected the Fed’s key interest rate to remain at 0.5 percent to 0.75 percent, following the central bank’s decision to lift interest rates at its previous two-day policy meeting in December. On Wednesday morning, futures markets pointed to a 96 percent chance that the Federal Reserve would remain on hold.
Yet markets were closely watching for clues as to how the Fed might pursue further interest rate hikes in 2017. In its statement, the Fed subtly hinted that the environment for such hikes might be improving.
While it said that inflation remained below its 2 percent long-run target, the Fed removed references to “declines in energy prices and in prices of non-energy imports” that it said had dragged on inflation. It also added that measures of consumer and business sentiment — seen as leading indicators of the direction of the economy — “have improved of late.”
Markets rose slightly after the Fed statement on Wednesday, climbing less than 1 percent before paring back gains.
While the Federal Reserve has long planned to pursue a slow but steady course of normalizing interest rates, it has emphasized that the pace will hinge on the progress of the economy. If the economic recovery begins to pick up speed, the central bank will also move more quickly to raise interest rates from the ultra-low levels at which they have hovered since the financial crisis.
President Trump’s election has buoyed expectations for growth, but also introduced a greater level of uncertainty about the direction of the economy. Trump has pledged to slash individual and corporate taxes and boost infrastructure spending through tax credits. These measures could spark further economic growth, but they could also drive up inflation — forcing the Fed to raise interest rates to keep prices stable.
Yet that path is not certain, economists say. They also point to Trump’s proposals of imposing high tariffs on imports from China, Mexico and other countries, measures that run the risk of triggering retaliation or even a trade war. That could clamp down on U.S. exports and the economy.
The market, so far, has expected the rosier scenario. Stock markets have rallied since Trump’s election with the Dow Jones industrial average closing above 20,000 for the first time on record. The dollar has also strengthened on expectations that tax cuts and spending will help to heat up the economy.
In its statement on Wednesday, the Fed gave no indication of how policy changes under the new administration might affect the economy.
In December, Federal Reserve Chair Janet L. Yellen said some Fed officials had incorporated estimates for how government spending might influence the economy into their forecasts. She also said that the Fed was “operating under a cloud of uncertainty” when it came to the economy’s course and that it would have to “wait and see what changes occur.”
Stephen Oliner, a resident scholar at the American Enterprise Institute, said that stimulative measures from the Trump administration did run the risk of igniting inflation, given low unemployment and the strength of the economy. “The Fed definitely is on high alert about the possibility that fiscal stimulus at this late stage of the cycle could be inflationary if it’s not met by a significant tightening in monetary policy.”
The Federal Reserve has long sought to gradually lift interest rates from the near-zero levels of the financial crisis. But in the past few years, its efforts have often been frustrated by unspectacular growth, low inflation and deep uncertainties in the global and domestic economy.
The Federal Reserve raised its benchmark interest rate at the end of 2015, the first increase since the Great Recession. In December it raised its benchmark rate again to the current level of between 0.5 percent and 0.75 percent. The Fed had initially anticipated as many as four hikes in 2016, but a stock market crash in China and Britain’s widely unanticipated decision to exit the European Union has encouraged the central bank to remain cautious.
“Right now our foot is still pressing on the gas pedal, though, as I noted, we have eased back a bit,” Yellen told a crowd at the Commonwealth Club in San Francisco in January. “Our foot remains on the pedal in part because we want to make sure the economic expansion remains strong enough to withstand an unexpected shock, given that we don’t have much room to cut interest rates.”
Going forward, the Fed aims to move gradually to head off signs of emerging inflation. By doing so, it hopes to avoid a situation in which inflation suddenly spikes and the Fed needs to raise its interest rate more quickly, a move which could run the risk of destabilizing the economy.
At its December meeting, the median expectation of the committee was for three rate hikes in 2017. The market remains more reserved, however, with the largest proportion of investors expecting two rate hikes this year to bring the Fed funds rate to between 1 and 1.25 percent. For the past several years, financial markets have been a more accurate predictor of what Fed policy has been than the Fed's own projections, said David Berson, chief economist at Nationwide Mutual.
Scott Anderson, chief economist at Bank of the West Economics, said in an email that the release contained few clues as to when to expect the next rate hike from the Fed — which probably suggests that an increase is unlikely at the committee's next meeting, in March. “We continue to expect the next rate hike … in June, 2017,” he said.
Trump’s measures come at a time when the economy is chugging along, though at a slower rate than some past periods of economic expansion. Economists say the U.S. labor market appears strong, with the unemployment rate now nearing pre-recession levels at 4.7 percent in December. Yet measures of GDP growth and inflation remain relatively tepid.
This combination has caused some economists to question whether the United States is still facing headwinds that will continue to evaporate in the next few years, or if the financial crisis somehow permanently moved the economy to a lower potential level of growth — for example, if workers retired early and no longer want to rejoin the labor force. In June, Yellen showed signs of embracing this second interpretation when she commented that slow growth and low inflation might be a “new normal.”
Economic projections released by the Fed in December indicated that the central bank expects the economy to grow 2.1 percent in 2017 and 2.0 percent in 2018. Those figures would be far below the 4 percent growth rates targeted by the Trump administration.
Trump has both publicly complimented and criticized Yellen. In mid-2016, he said he had “great respect” for her. But he also repeatedly accused her and the Fed of keeping rates low to boost economic growth and cement former president Barack Obama’s legacy — claims Yellen has firmly denied.
“I think she is very political, and to a certain extent, I think she should be ashamed of herself,” Trump said in September.
Yellen has signaled that she will serve out the remainder of her term, but analysts believe Trump may replace her when that term ends on Feb. 3, 2018. With his election, Trump immediately inherits two vacant spots on the board of governors, which help to set monetary policy.