Fed Policy Little Changed

The Federal Reserve met for two days last week to set monetary policy and update projections for economic growth, employment and inflation.  FOMC members reduced their 2014 GDP estimates to reflect the weak 1st quarter but left their 2015, 2016 and long-run estimates largely unchanged.  Interestingly, the Fed is looking for 2015 and 2016 GDP growth to be well above the long-run average and for employment in 2015-2016 to return to levels consistent with a healthy labor market.  These predictions would generally coincide with a return to more normalized monetary policy, but FOMC members expect the current zero interest rate policy to continue through at least the end of the year.  This divergence between data and policy is likely due to the Fed’s concern over inflation.  CPI ex. food and energy was reported last week at positive 2.0%, the highest level since the summer of 2011, but Fed Chair Janet Yellen largely dismissed this as transitory.  All eyes now turn to Thursday, when another measure of inflation, the PCE Deflator, will be released.  Some economists believe inflation has bottomed and is trending up.  We have seen some early signs of inflation and are taking a cautious stance in regard to duration positioning in client portfolios.  If inflation continues its move higher, interest rates will likely follow, putting us in a good position to reinvest our short maturity bonds at higher rates when they come due.