Since the start of the year, investors and economists have been focused on this month’s FOMC meeting; specifically, whether or not this would be ‘the one’—the meeting that announced a change in regime, from extreme emergency accommodative low rates to the start of tightening.  Due to sporadic data since that time, it became more obvious over time that it was not to be.

The statement language reflected a moderate expansion of economic growth and job gains in recent months, while acknowledging the mixed nature of consumer spending, housing and business capex.

Many look at the ‘dot plot,’ which is a graph attached to the official statement showing the path of rates expected by FOMC members over the next several years—changes in these dots from last meeting are interpreted as a sentiment shift.  As it stands, it appears the general expectation is a raising of rates twice by the end of 2015 (probably in the fall, as the July meeting doesn’t feature a press conference).  It’s almost hard to believe, but two years hence—by end of 2017—members expect fed funds rates to be at 3% or so (given a range of +/- 0.5% in either direction).

A look at the dashboard:

Economic growth.  The first quarter GDP report was terrible, but this was largely discounted away as a weather- and seasonality-adjustment-based anomaly.  Hopes are for improvement for this quarter and the remainder of the year, but reports over the past few months have been mixed.  Estimates continue to fall in the 2.5-3.0% for this quarter, the remainder of this year, and into next, assuming a pickup in growth occurs as planned.

Employment.  The headline situation with nonfarm payrolls and the unemployment rate has looked better, but other sources show a better story—such as low levels of jobless claims.  Peripheral measures like the ‘quit rate’ have bounced around at levels stronger than those of the past several years, although there could be further room for improvement.  A deep-seeded fear of some economists is that the jobs picture just won’t get that much better, with increasing retirements, inherent structural demographic shifts and automation.  This is fodder for another discussion, but it’s relevant to near-term Fed expectations and how realistic or not targets are to achieve.

Inflation/monetary stability.  The severe drop in oil prices last year created a vacuum for dramatically lower imported headline inflation.  That certainly occurred—in fact, so much so, that deflationary side effects became a worry.  The Fed’s inflation target of  2% has represented a line in the sand somewhat to keep accommodation turned on until that level is reached.  Core inflation has looked stronger recently, and may provide the wanted (?) price increases as the very low year-over-year headline figures roll off.

Investment markets have naturally been watching Fed statements and speeches closely.  Bond markets in particular have suffered a bit in recent weeks as interest rates moved dramatically upward (dramatic being of the half-percent range—a fraction of the rate spike in Europe that was twice that).  Two opposing forces appear to be at play:  the natural push towards higher rates as Fed policy inches toward finally taking action vs. the continued downward pressures from foreign inflows as yields remain quite competitive (given the perceived high levels of safety) compared to options abroad.

The fact that markets have moved in advance of the Fed isn’t surprising, and being shorter in duration has helped matters in portfolios—albeit this was an ‘insurance’ price paid for being somewhat early.  Equities can also face additional volatility from sudden rate moves, but the surprises are not coming from the Fed.  It appears more likely that a policy mistake, mis-communication or overreaction in the Eurozone/Greece negotiations, disappointing results from China, or other geopolitical item could be a higher-probability cause of volatility, if that happens. The best news is that, historically, equity markets have tended to perform positively in the year following rate increases, based on the assumption that higher rates occur alongside stronger growth.