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Now we know what the Fed is thinking

After weeks of waiting, the two-day FOMC meeting took place and clued us into their thought process. Committee members voted to keep the target lending rate unchanged. That was not a surprise. What was a surprise was the extent the committee lowered its projections for future rates. The Fed lowered its estimate for rates 25 to 60 basis points in its quarterly forecast. The target rate is expected to reach only 1.60 percent by the end of 2017, 2.40 percent at the end of 2018 and 3.00 percent longer term. The Committee acknowledged that while the overall economic picture has improved, conditions still warrant a cautious approach. Federal Reserve Chair Janet Yellen alluded to the recent weakness in the labor market to confirm the Fed’s watchful strategy. Since the last FOMC meeting in April, the labor market has slowed, while housing and consumer spending have picked up. The Committee’s outlook, however, is optimistic, and they believe the labor market will turn around and inflation will move higher in the long term. The Fed believes low interest rates are needed at this time to keep the economy growing. Just this morning, it was revealed that the Federal Reserve Bank of St. Louis’s updated model suggests the fed funds rate should remain at 0.625 percent over the next two-and-a-half years due to uncertainty regarding the economy's progress.

Other Key Indicators this Week:

Retail Sales – For the second month in a row, sales at retailers were strong. Retail sales rose 0.5 percent in May, following a 1.3 percent gain in April. The back-to-back gains make this the best second quarter start since 2004. Nine of the 13 categories reported gains. Gasoline station sales posted the largest increase, up 2.1 percent, a result of rising fuel costs. Aside from gasoline, most of the gains in the index were in the discretionary categories, including sporting goods, clothing and restaurants. The weakest category was building materials, falling for the third consecutive month. Overall, the consumer is back in action as wages continue to improve and confidence builds in the economy.

Housing – Construction activity on new homes during May was barely noticeable. Housing starts fell 0.3 percent, while April activity was revised almost two percentage points lower to 4.9 percent. The silver lining in the otherwise weak report was stronger activity in single-family housing (up 0.3 percent), compared to multi-family housing (down 1.2 percent). The housing industry continues to battle record high prices as inventory shrinks.

Inflation – Changes in food and energy costs were the main forces behind two key inflation indices in May. Wholesale prices rose for the second month in a row, increasing 0.4 percent in May. The jump was driven largely by energy costs. Energy prices were up 2.8 percent, the largest increase in a year. On the consumer side, prices rose 0.2 percent on both headline and core levels. A 2.3 percent increase in gasoline prices was partially offset by a 0.2 percent decline in food prices and a 0.1 percent drop in auto prices. The core year-over-year rate rose to 2.2 percent, just below the recent 2.3 percent level reached in February, which was a four-year high rate.

Strategically for Credit Unions:

If you believe the Fed, get ready for more of the same. Interest rates appear to be on a steady path of remaining low. The 10-year Treasury note yield fell to the lowest level since December 2012. The low interest rates should keep loan demand strong, but will also continue to put pressure on net interest rate margins. The difference between short-term and long-term rates is the narrowest since December 2007. The fed funds futures market is placing a 35 percent probability on a rate move in December.

Sarina Freedland – Senior Investment Officer


Although this information has been obtained from sources we believe to be reliable, we do not guarantee its accuracy, and it may be incomplete or condensed. This is for informational purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security. All herein listed securities are subject to availability and change in price. Past performance is not indicative of future results. Changes in any assumption may have a material effect on projected results.

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