Monetary Policy’s Slow Path to Normalization

Growth and Monetary Policy

August 28, 2017

LPL Financial

According to a new white paper from LPL Research, Midyear Outlook 2017: A Shift In Market Control, moderate 2.5% GDP growth in 2017 will prompt the Federal Reserve to back off its emergency monetary policy and raise interest rates two or three times. Low labor force participation and a more stable dollar are expected to keep inflation down.

We expect two or possibly three hikes in 2017 as the central bank gradually removes its support.

- Midyear Outlook 2017: A Shift In Market Control

Growth Prompts a Change in Fed Policy

Another Federal Reserve rate hike in June signals confidence in the economy, but in their Midyear Outlook publication, LPL Research indicates future hikes may be gradual.

The Fed has been slowly powering down support since it started tapering its bond purchases in January 2014. Although the slow path to normalization accelerated in the first half of 2017, we expect the Federal Open Market Committee’s (FOMC) gradual approach to rate hikes to continue and look for two or three rate hikes in 2017.

The full report also suggests that steady growth, despite being below trend, has freed the Fed from emergency-level policy measures. Still, it’s limited by forces such as excess manufacturing capacity, a low labor force participation rate, and a more stable dollar. These forces push down inflation, which makes an extended run meaningfully above the Fed’s 2% target “unlikely,” according to LPL Research.

Additionally, the Midyear Outlook indicates the likelihood of slow job growth and low wage growth. Historically, central bankers have aggressively raised interest rates at 4.0% wage growth, but the 2.5% wage growth we’re now seeing is enough to keep the Fed on its stated track.

According to the report, overseas central bank policy is also contributing to US interest rates. Low rates overseas, particularly in Europe and Japan, are preventing US rates from moving significantly higher.

For more in-depth analysis of monetary policy and other trends shaping markets, download the Midyear Outlook whitepaper from LPL Research.

Economic forecasts set forth may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.