Lacker, Kaplan, Fischer, by Tim Duy: Today Richmond Federal Reserve President Jeffrey Lacker argued that the case for rate hikes remains intact, arguing that monetary policy remains quite accommodative:
So at this point, estimates of the natural real rate of interest do not suggest that the zero lower bound is impeding the Fed’s ability to attain its 2 percent inflation objective. In fact, this perspective would bolster the case for raising the federal funds rate target.
And in he is quoted by Reuters adding:
Ongoing strength in the U.S. job market could give the Federal Reserve justification for multiple interest rate increases this year, Richmond Fed President Jeffrey Lacker said on Wednesday....."I still think prospects for rate increases this year is the logical" view, Lacker said in a presentation to a business school in Baltimore, adding that economic data did not indicate that a recession was imminent in the United States.
If Lacker were still voting this year, he would likely be a serial dissenter. On the opposite side of the table sits Dallas Federal Reserve President Robert Kaplan. In an interview with the Financial Times, Kaplan leans very dovish:
Now was a time for patience as the Federal Reserve seeks to understand the impact of financial market turbulence and slowing growth in other economies, said Mr Kaplan, who does not vote on Fed rates this year but takes part in the debate.“In order to reach our inflation objective we may need to be more patient than we previously might have thought,” he said. “If that means we take an extended period of time where we stop and don’t move, that may also be necessary. I am not prejudging that.”
Pure wait-and-see, risk management mode, and the most likely direction the Fed will take in March and April. Federal Reserve Vice Chair Stanley Fischer remains less-moved by recent developments. Instead, low unemployment rates capture his attention (emphasis added):
..most estimates of the full employment rate of unemployment are close to 5 percent. The actual rate of unemployment is now slightly below 5 percent, and the median view of the members of the FOMC is that it will decline further, perhaps even to the vicinity of 4.7 percent. The question is, should we be concerned about that possibility? In my view, a modest overshoot of this sort would be appropriate in current circumstances for two reasons. The first reason is that other measures of labor market conditions--such as the fraction of workers with part-time employment who would prefer to work full time and the number of people not actively looking for work who would like to work--indicate that more slack may remain in the labor market than the unemployment rate alone would suggest. And the second reason is that with inflation currently well below 2 percent, a modest overshoot could actually be helpful in moving inflation back to 2 percent more rapidly. Nonetheless, a persistent large overshoot of our employment mandate would risk an undesirable rise in inflation that might require a relatively abrupt policy tightening, which could inadvertently push the economy into recession. Monetary policy should aim to avoid such risks and keep the expansion on a sustainable track.
Unemployment is currently at 4.9 percent. It doesn't take much imagination to see it falling to 4.7 percent in short order. Fischer sounds very uncomfortable with the prospect of the unemployment rate falling much below 4.7%. He is getting an itchy trigger finger.
I remain unmoved by this logic:
If the recent financial market developments lead to a sustained tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the United States. But we have seen similar periods of volatility in recent years--including in the second half of 2011--that have left little visible imprint on the economy, and it is still early to judge the ramifications of the increased market volatility of the first seven weeks of 2016. As Chair Yellen said in her testimony to the Congress two weeks ago, while "global financial developments could produce a slowing in the economy, I think we want to be careful not to jump to a premature conclusion about what is in store for the U.S. economy."
This echoes the comments of San Francisco Federal Reserve President John Williams, and again misses the Fed's response to financial turmoil. In 2011, it was Operation Twist. One would think they would keep a chart like this on hand:
I really do not understand how Fed officials can continue to dismiss market turmoil using comparisons to past episodes when those episodes triggered a monetary policy response. They don't quite seem to understand the endogeneity in the system.
My sense is that there remains a nontrivial contingent within the Fed that really, truly believes they need to hike sooner than later for fear that overshooting the employment mandate will result in overshooting the inflation target. This contingent is attempting to look at the financial system as separate from the "real" economy. That will not work. No matter how good the underlying fundamentals, if you let the financial system implode, it will take the economy down with it. I don't know that the Fed needs to cut rates, or that they needed to cut rates as deeply as they did during the Asian Financial crisis, but I do know this: The monetary authority should not tighten into financial turmoil. Wait until you are out of the woods. That's Central Banking 101. And I suspect that is ultimately the direction the Fed will take.
Bottom Line: Despite some hawkish talk, the Fed will find themselves in risk management mode at the March meeting. Some will not like it. There will remain a contingent that fears standing still risks excessive overshooting of the inflation target.