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Monday, November 23, 2015

Fed Watch: Mission Accomplished

Tim Duy:

Mission Accomplished, by Tim Duy: Federal Reserve policymakers have pretty much taken all of the mystery out of this next meeting. Federal Reserve Vice Chair Stanley Fischer, via Reuters:

"In the relatively near future probably some major central banks will begin gradually moving away from near-zero interest rates," Fed Vice Chairman Stanley Fischer told the San Francisco Fed's biannual Asia Economic Policy conference.

"While we at the Fed continue to scrutinize incoming data, and no final decisions have been made, we have done everything we can to avoid surprising the markets and governments when we move, to the extent that several emerging market (and other) central bankers have, for some time, been telling the Fed to 'just do it'."

New York Federal Reserve President William Dudley, via Reuters:

The Federal Reserve should "soon" be ready to raise interest rates as U.S. central bankers grow confident that low inflation will rebound and that employment remains stable, William Dudley, the influential head of the New York Fed, said on Friday.

"We hope that relatively soon we will become reasonably confident that inflation will return to our 2 percent objective," he said at Hofstra University. Dudley said it was "very logical" to expect that the Fed's inflation and employment conditions would be met "soon," allowing policymakers to "start thinking about raising the short-term interest rates."

Atlanta Federal Reserve President Dennis Lockhart, via CNBC:

A top Federal Reserve official said Thursday he is "comfortable" with raising the federal funds rate "soon," as concerns about low inflation and global risks are not persuasive enough to keep interest rates near zero.

"I'm comfortable with moving off zero soon," said Atlanta Fed President Dennis Lockhart in prepared remarks.

San Francisco Federal Reserve President John Williams, via Reuters:

"The data I think have been overall encouraging, especially on the labor market," San Francisco Fed President John Williams told reporters after a conference at University of California Berkeley's Clausen Center.

"Assuming that we continue to get good data on the economy, continue to get signs that we are moving closer to achieving our goals and gaining confidence getting back to 2-percent inflation... If that continues to happen there's a strong case to be made in December to raise rates."

Obviously serial dissenter Richmond Federal Reserve President Jeffrey Lacker is also looking for a rate hike. And so too is Cleveland Federal Reserve President Loretta Mester. To be sure, they all give a nod to “data dependence,” implying that a rate hike is not a sure thing. But, barring an outright collapse in financial markets, it is very difficult to see the data evolve between now and December 15-16 in such a way that the Fed suddenly has a change of heart. And note there is little reason for them to think at this point that growth has slowed well below trend. It is widely expected that Q3 GDP is this week revised up to 2.1% while current quarter GDP is tracking at 2.3%. While in 1990s terms these are not staggering numbers, in 2010 terms they exceed the Fed’s estimate of potential GDP growth. And with more and more Fed officials convinced the economy is operating near full employment, anything over 2% raises worries on Constitution Avenue that the economy might overheat.

Now, we still have one employment report ahead of us. Aside from the now-reversed equity declines in August, recall from the last minutes that uncertainty regarding the labor market helped stay the Fed’s hand:

In assessing whether economic conditions and the medium-term economic outlook warranted beginning the process of policy normalization at this meeting, members noted a variety of indicators, including some weaker-than-expected readings on measures of labor market conditions, and almost all members agreed it was appropriate to wait for additional information to clarify whether the recent deceleration in the pace of progress in the labor market was transitory or reflected more persistent factors that might jeopardize further progress.

It would seem that the October labor report put an end to those concerns. Consequently, the following comes into play:

Members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting, provided that unanticipated shocks do not adversely affect the economic outlook and that incoming data support the expectation that labor market conditions will continue to improve and that inflation will return to the Committee's 2 percent objective over the medium term.

I suspect that only an outright disaster in the November labor report would prompt the Fed to take a pass at the December meeting. It is just simply the case that given their Phillips curve framework, they are running out of reasons not to raise rates. They would need enough weak data to fundamentally alter their outlook to the downside, and it is hard to see that happening in the short time remaining.

Consequently, it is hard to come to any other conclusion than that they are going to raise the target range on the federal funds rate in December. In Fedspeak, they might as well be screaming it into your ears.

While they may be taking the mystery out of the first rate hike, however, they are trying to put the mystery into subsequent rate hikes. Lockhart, via Reuters:

"The pace of increases may be somewhat slow and possibly more halting than historic episodes of rising rates," Lockhart said in a speech to the DeKalb Chamber of Commerce in Atlanta.

Williams, via Reuters:

"We definitely do not want to, either through our actions or our words, indicate a preference for a very mechanical path of interest rates, whether it’s every other meeting or however you think about it," Williams said. "Since economic data can surprise on the upside and the downside, maybe there will be opportunities to show we are data dependent."

And St. Louis Federal Reserve President James Bullard, via Bloomberg:

“When we had a normalization in 2004 to 2006 we moved at the same 25 basis points per meeting for 17 meetings in a row,” Bullard said. “I am virtually certain that was not optimal monetary policy. That was a very mechanical approach to increasing rates. This time I am hopeful we can be more flexible and reactive to data.”

How will they communicate uncertainty in the path of rate hikes? I wonder if they can simply retain this sentence in the next statement:

In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation.

It seems like this could be used to convey uncertainty in subsequent meetings, especially if they choose not to hike in January.

Bottom Line: The Fed is set to declare “Mission Accomplished” at the next FOMC meeting. Indeed, many policymakers have already said as much. Absent a very significant change in the outlook, failure to hike rates in December would renew the barrage of criticism regarding their communications strategy that prompted them to highlight the December meeting in their last statement. Once they have communicated their intentions for subsequent rate hikes, they will turn their attention to the issue of normalizing the balance sheet. Even though officials have not committed to a specific path, I am working with a baseline of 100bp of tightening between now and next December, or roughly 25bp every other meeting. I expect that by the second quarter of next year they will begin communicating the fate of the balance sheet. Whether they should hike or not remains a separate issue. Over the next twelve months we will learn the extent of which the Federal Reserve can resist the global downward pull of interest rates. Other central banks have been less-than-successful in their efforts to pull off of the zero bound – not exactly a hopeful precedent.

    Posted by on Monday, November 23, 2015 at 12:15 AM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (34)


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