Broker Talk: When Will the Fed Raise Rates?

Investors are beginning to wonder when the Federal Reserve will raise interest rates. Judging by last week’s Fed meeting, it probably won’t be anytime soon, these brokerages say.

Who’s Talking: Liz Ann Sonders, Senior Vice President and Chief Investment Strategist, Charles Schwab & Co.

The Gist: The Fed may be shifting gears on the economy, but it’s in no hurry to raise interest rates.

The Federal Open Market Committee (FOMC) meeting last week gave no hint of an answer about when the Fed will end its monetary stimulus, says Sonders. (The fed funds target rate remained unchanged, between 0% and 0.25%, a range that has been in place since December 2008.) But the announcement was more detailed and optimistic than previous statements, leaving some wondering if the Fed may be closer than expected to raising interest rates, says Sonders. Words such as “increased” and “picked up” replaced words from previous announcements such as “leveling out” and “stabilizing.” The Fed said fiscal and monetary stimulus and improving financial conditions would “support a strengthening of economic growth and a gradual return to higher levels s of resource utilization in a context of price stability.” It also said it will slow its purchasing of mortgage-backed securities and housing-agency bonds, eventually ending a $1.45 trillion program.

These are slight shifts in the Fed’s stance, says Sonders, but the Fed won’t pull back the reins any time soon, since it is “highly sensitized” to the fact that the U.S. private sector is still winding out of extreme over-leverage.

It also wouldn’t want to repeat the mistakes of the Great Depression, she says, when the government pulled back on economic stimulus programs too quickly. The Fed also has to pursue policies that fall in line with its dual mandate of “full” employment and low inflation. And since unemployment has climbed all the way to 9.7% but inflation is still in check (below 2%), Sonders says rate hikes are unlikely to be on the horizon.

But some still expect the Fed to act soon, and Sonders says that could happen if the Fed is forced into raising rates under conditions of stronger-than-expected economic growth. Inflation, on the other hand, isn’t likely to drive Fed rate hikes, she says, since banks are still stockpiling reserves and shrinking their assets. Meanwhile, demand for credit is still down. There is also still excess global capacity for manufacturers around the world, which doesn’t add up to “the makings of an inflation problem,” she says.

Overall, the economy still has room to grow more robustly without raising rates, says Sonders. That is, as long as there isn’t a sharp drop in unemployment and/or a “meaningful uptick in inflation expectations.”