As expected, the Federal Reserve made no change to its policy interest rate at today's meeting. There were a few tweaks to the language of the statement, however, that clarify officials' thinking. (The Wall Street Journal usefully tracked all the changes made since March.)
Just as interesting is what did not change. In both cases, the interesting language is all about inflation.
Inflation has been slower than the Fed's longer-run goal of 2% yearly growth in the PCE price index excluding food and energy almost continuously since the Fed announced its target back in January 2012. Every time it seemed as if inflation was accelerating to 2%, it ended up slowing back down. The most striking example was just last year, when yearly core inflation slowed from 1.9% in February to just 1.3% by August.
A big spike in March (which could always be revised) has returned the core inflation rate to 1.9%. The Fed acknowledged this in its latest statement, noting that "both overall inflation and inflation for items other than food and energy have moved close to 2 percent." Previously, the line was "both overall inflation and inflation for items other than food and energy have continued to run below 2 percent."
This modest acceleration of inflation had long been expected and incorporated into previous Fed forecasts of the policy interest-rate band, which explains why the Fed has been so sanguine about it. Just to reinforce the point, the Fed added the word "symmetric" to its description of its inflation objective. The idea is that the Fed is willing to endure temporary periods when prices may rise faster than 2%, just as it had been willing to endure periods when prices rose slower than its longer-run goal.
The surprising bit of the statement is what the Fed left in from previous meetings: "Market-based measures of inflation compensation remain low." This is difficult to justify. The most common measure is the break-even inflation rate between U.S. Treasury notes and their inflation-indexed equivalents five years in the future. This is at its highest level in years and broadly consistent with a 2% inflation goal.
Another measure is the median five-year inflation rate implied by options prices. This, too, is at its highest level in a long time and broadly consistent with prices growing by 2% each year. Moreover, the implied probability that inflation ends up averaging 3% or more over the next five years is at comparable levels to when the Fed felt good about the world in 2013-2014.
Whatever the reason for including the language about market-based measures in the latest statement, the effect is likely to reinforce traders' views that the Fed will be cautious about raising rates too quickly.
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