U.S. Fed changes guidance, but timing still unclear on rate hikes

The U.S. Federal Reserve says it can no longer remain "patient" about changing rates, an indication that interest rate hikes could begin this spring.

But in a news conference, Fed chair Janet Yellen said the central bank has not settled on the timing of the rate hike.

Analysts were encouraged by the numbers released with the Fed’s statement, which indicate the funds target rate would be raised only half a point by year-end. That’s lower than it previously anticipated.

Derek Holt, vice-president of Scotiabank Economics, said the Fed seems to be cautious about hiking rates.

"Despite removing 'patient' from the statement which increases flexibility for timing liftoff as early as June, on balance the FOMC turned incrementally more dovish on the pace of projected interest rate increases over 2015-17 and backed this up with downward forecast revisions to growth and inflation,” he wrote in a note to investors.

Since last December, Yellen and the Fed have been saying that they "can be patient" in the timing of when rates are raised.

In the announcement today, the Fed open market committee dropped the word "patient" on the timing of raising its benchmark interest rate. It specified it would not raise rates as soon as April, though the Fed specified it has no specific time in mind.

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"This change does not mean that an increase will necessarily occur in June, though the committee can't rule that out," Yellen said in her news conference. June would likely be the earliest date.

Depends on the economy

Everything will depend on the U.S. central bank's assessment of the U.S. economy over the next few months, the Fed said in a statement issued at 2 p.m.

"In determining how long to maintain this target range, the committee will assess progress — both realized and expected — toward its objectives of maximum employment and two per cent inflation," it said in the statement, noting that inflation remains too low.

"This change in the forward guidance does not indicate that the committee has decided on the timing of the initial increase in the target range."

Unemployment in the U.S. is approaching its target range of 5.5 per cent and its GDP grew 2.2 per cent in the fourth quarter, according to latest estimates.

But the bank is also concerned about indicators such as wage growth, labour participation, inflation and consumer spending, which have not yet improved as much as the Fed might like. It has downgraded some of its projections for growth for the rest of the year.

Inflation remains low

In its current assessment of the economy, the Fed said U.S. GDP would grow by 2.3 to 2.7 per cent in 2015 and the same in 2016. It projected unemployment would decline to 5.0 to 5.2 per cent this year, meaning it would fall below the Fed’s previous target rate without increasing inflation.

The central bank pointed to current low inflation, in the 1.3-1.4 per cent range this year as oil prices and a high dollar keep costs low in the U.S. It projected inflation would rise in the "medium-term" to closer to its target rate of two per cent.

Yellen said the numbers for the first quarter of 2015 show that growth has declined somewhat, due to international conditions and a high dollar.

"A very strong dollar is one of the reasons for that; on the other hand, a strong dollar reflects the strength of the U.S. economy," she said.

Mark Grant, an analyst with Southwest Securities, said the more significant part of the Fed's release might be the slower approach to raising rates.

"The lack of the word 'patient' is hugely overshadowed in my view by their statement about short-term rates. They cut their outlook for 2015 from 1.125 per cent on federal funds to 0.625 per cent," he said in a note to investors.

Dan Greenhaus, chief strategist at BTIG, said the Fed's statement Wednesday lowered the odds of mid-year rate hike.

"What's important about this part of the statement is that it clearly says the FOMC is looking for 'further' improvement, meaning the economy and labour market have not yet met whatever criteria necessary to warrant a rate hike," Greenhaus said in a note to clients.

Markets like today's announcement

Any indicators of U.S. strength are good news for Canada, which can expect an uptick in demand for Canadian goods. A rate increase in the U.S. would likely weigh on the Canadian dollar, especially as the Bank of Canada has said it may not raise rates in line with the Fed.

The markets have reacted negatively to the prospects of rate hikes, fearing an interest rate hike might weigh on stock values and push up the U.S. dollar, making American goods more expensive.

As with its decision last year to taper off its bond-buying program, there is volatility ahead of Fed's potential rate hike, but the hike itself may find markets already prepared.

Stocks shot upwards in New York and Toronto on Monday after the rate announcement as investors gauged that the Fed is projecting a very slow pace of increases for rates.