Fed Avoids November Surprise, Eyes December as Rates Stay Steady

The Federal Reserve avoided a November surprise on Wednesday, opting to keep short-term interest rates on hold at the conclusion of its policy meeting.

In an 8-2 decision, members of the Federal Open Market Committee said while economic conditions continue to improve, and the case for higher rates has “strengthened,” they will wait for “some further evidence of continued progress.”

Central bank members cited strong job gains, an uptick in household spending and somewhat higher inflation from the start of the year as contributing factors to economic growth. However, business fixed investment continued to be a weak spot alongside low market-based measures of inflation. Members also said they see inflation levels rising closer to the 2% objective in the medium term as transitory effects of energy declines dissipate.

Though Fed Chief Janet Yellen has repeatedly said the central bank remains politically neutral, the decision comes less than a week before Election Day and the conclusion of a historically contentious political season. Wall Street expectations, as measured by federal funds futures, pegged the odds of a rate rise at just 7% ahead of the decision as it was widely believed the Fed would not want to rock the boat before voters head to the polls.

“I don’t think anyone was looking for the Fed to make a move. The key has always been how strongly they communicate a move in December,” said Mike Baele, managing director at U.S. Bank’s Private Client Reserve. “[Still,] my gut feels that absent next Tuesday, the Fed would have raised today.”

Slowly-rising inflation levels have been a thorn in the central bank’s side since its decision last December to raise rates by 0.25%. Core personal consumption expenditures (PCE), the Fed’s preferred inflation gauge, slipped last quarter to 1.7% from 1.8% in the second quarter, but is still hovering near 2%. In a sign of confidence for the inflation outlook, the Fed changed its statement language to say inflation “has increased somewhat since earlier this year,” compared to earlier statements that read inflation “continued to run below the committee’s 2% longer-run objective.”

“We believe that a combination of incoming data on labor markets and inflation, along with building concerns within the committee about medium-term risks to financial stability, will the balance in favor of a rate hike at the December meeting,” economists at Barclays estimated.

Indeed, the Labor Department will release its October jobs report on Friday – economists expect to see a net gain of about 175,000 jobs with a lower unemployment rate of 4.8%. However, ADP figures released on Wednesday, which came in below consensus, signaled the more closely-watched non-farm payrolls report could be a little weaker than expected.  Despite that, Baele said it would take a hugely disappointing labor-market report to knock the Fed off its supposed December rate-hike course.

As the labor market maintains its firmness, and inflation continues on its upward trajectory, the Fed will likely be more apt to move in December while keeping expectations tempered for future rate hikes, said Steve Chiavarone, portfolio manager at Federated Investors.

“They’ll hike [in December] and thread the needle they couldn’t last year…this year, they’ll hike again in December but likely signal one or two hikes in 2017,” he predicted.

Market expectations show a 71% chance of a hike coming next month, up from odds of 68% Wednesday.

Still, Baele said the Fed will make sure this time around, it doesn’t box itself into a specific deadline to move rates higher.

“The Fed doesn’t’ ever want to be locked into a calendar decision; they always want it to be based on the data. I think they have tried hard in this statement to keep the focus on the data,” he said.