Fed holds rates steady, leaves door open to December hike

WASHINGTON -- The Federal Reserve held its key interest rate steady Wednesday and left the door open to a December rate hike amid an improving economy.

In a statement after a two-day meeting, the Fed said it decided to keep its federal funds rate at a historically low 0.4%.  The Fed said “the case for a rate increase strengthened” but policymakers decided, “for the time being, to wait for some further evidence of continued progress toward its objectives.” That largely mirrored the September statement, except the Fed added that only “some” additional advances are needed, suggesting a rate hike may be at hand.

The statement added that “inflation has increased somewhat since earlier this year” and removed its previous assertion that “inflation is expected to remain low in the near-term.” The Fed’s preferred measure of annual inflation, which excludes volatile food and energy costs, is still below its 2% annual target but it has edged up steadily this year, reaching 1.7% recently. That could pave the way for a rate hike as soon as December.

Stocks, already on pace for a seventh down day, fell further briefly after the decision, but quickly staged a recovery Of the three major indexes, the Nasdaq dropped the most, down 0.9% for the day. The S&P 500 and Dow Jones industrial average lost 0.7% and 0.4%, respectively. It was a 77-point loss for the Dow.

Some economists said the Fed was unlikely to send an explicit signal of a December rate increase similar to a reference in October 2015 to a possible hike at the “next meeting.” With markets already pricing in an increase anyway, Fed officials would prefer not to close off their options, the economists said.

"Absent substantial shocks, they're set on December," says UBS economist Drew Matus. Among potential shocks are a contested presidential election next week or a victory by Republican Donald Trump that roils markets, says economist Paul Ashworth of Capital Economics.

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After Wednesday’s statement was released, fed fund futures reckoned there was a 72% chance the Fed will lift its benchmark rate at a Dec. 13-14 meeting, up from 68% a day earlier.

Economists, and some Fed officials, suggested it was unlikely the Fed would act just days before the election, potentially disrupting markets and coloring perceptions of the economy and presidential candidates Trump and Hillary Clinton.

Also, the economy has been mixed lately, with employers adding a modest 156,000 jobs in September. The government said last week the economy picked up steam in the third quarter after nine months of feeble growth, expanding at a healthy 2.9% annual rate. But consumer spending and business investment increased modestly.

Fed policymakers said Wednesday “the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of the year,” echoing its previous statement. “Job gains have been solid,” it added, despite the recent slowdown.

Kansas City Fed President Esther George and Cleveland Fed chief Loretta Mester dissented again from the Fed’s decision to stand pat, favoring a quarter percentage point rate increase. But Boston Fed President Eric Rosengren, who dissented in September, voted with the majority on Wednesday.

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Some economists didn’t rule out the possibility of a rate hike after three policymakers broke ranks in September. The Fed has stood pat since raising its federal funds rate in December for the first time in nine years, citing factors such as China’s economic slowdown, the United Kingdom’s Brexit vote, volatile markets and a spring slump in U.S. job growth.

Although all these headwinds generally have eased, the weak economy earlier this year stoked some concerns and the unemployment rate has been stagnant at 5%.

Fed Chair Janet Yellen traced the latter trend on the return of discouraged workers to an improving labor market, which has increased the labor supply and tempered wage growth and inflation. Yellen called this a positive shift she wanted to encourage by keeping rates low a bit longer, noting the economy had “more room to run.”

But some Fed officials voiced worries that waiting too long could force policymakers to eventually boost rates abruptly to catch up to inflation -- which could risk a recession -- or encourage bubbles in assets such as commercial real estate.