What Are the 3 Incredible Fed Reserve “Variables”?

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The Federal Reserve is being more transparent, trying to lead investors and the markets with better guidance on their potential actions.

They’ve now winded down their bond-buying program. Next in line is increasing the Fed interest rate. But what do they look at before they pull the trigger?

GDP, Unemployment and PCE Inflation

The brain trust looks at three different variables. Really its four but one is just two different, but very similar, inflation numbers. You can take a look at their latest projections in this PDF.

GDP is, of course, the biggie. If our economy is shrinking, slowing or growing that’s gonna make a huge difference to Fed behavior. Next year they predict a range of 2.1 to 3.2 percent growth. And we just got quarterly numbers saying GDP grew by 3.9 percent!

That’s good news and confirms the belief that they will raise rates in 2015. Fully fourteen, of seventeen, members think 2015 will be the right time to raise rates. Only two members think 2016 is the prime time. So its a good bet that next year we’ll see rates move up.

They also expect unemployment to drop to as low as 4.7% in 2017. Or as high as 5.8 percent, depending on which Fed member you believe. The lower number would be an even bigger improvement than we’ve already seen.

The inflation figure is based on Personal Consumption Expenditures, or PCE inflation. Here they project very moderate rates no higher than 2.4% and maybe as low as 1.5 percent. That’s very moderate and below the 3 percent historical average.

With inflation expectations low rates should move up pretty slowly. They don’t have to put on the brakes quickly to control runaway price increases.

What’s an investor to do? Make sure sure you have plenty of risk exposure, short-maturity bonds and alternative bonds that behave differently than traditional bonds. Also, make sure you’re long-term bond exposure is very light.

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