The Fed decided to delay the normalisation of official rates—primarily because of global financial and economic uncertainty, which, in its view, temporarily overshadowed stronger labor markets and a better-than-expected domestic economy. Policymakers still expect a rate hike before year-end, but it’s hard to gauge what would compel them to action, since they keep modifying their reasons and, thus, moving the goal-posts.
The changing script
At the September 16–17 Federal Open Market Committee (FOMC) meeting, policymakers voted 10 to 1 to leave official rates unchanged. They acknowledged that the domestic economy was growing at or above their expected pace and that labor-market improvement had exceeded their expectations. Yet policymakers were concerned that “recent global economic and financial developments may restrain domestic growth and put further downward pressure on inflation.”
While policymakers had included language concerning international developments earlier this year, this was the first meeting that it appears to have overshadowed the domestic economy. In fact, Fed Chair Janet Yellen conceded during Thursday’s press conference that “the recovery from the Great Recession has advanced sufficiently far and domestic spending appears sufficiently robust that an argument can be made for a rise in interest rates at this time.”
A Widening gap among policymakers?
The one dissent came from Federal Reserve Bank of Richmond President Jeffrey Lacker, who wanted to raise the target on the federal funds rate by 25 basis points. Mr. Lacker’s dissent was not a surprise as he has argued that the Fed’s labor market mandate has been achieved and a zero rate policy is no longer required.
At this time, most policymakers still expect to raise official rates before year-end. In fact, six of the 17 FOMC participants are currently calling for two rate hikes before year-end.
However, four participants are now calling for no rate hike until 2016—up from two members at the last meeting. With only two meetings remaining on the calendar before year-end, there seems to be a widening split on the committee. Still, on balance, the majority of policymakers expect one 25-basis-point hike before year-end. In the press conference Q&A, Yellen indicated that the upcoming October 27–28 FOMC meeting should still be considered a “live” meeting, even though it won’t be followed by a press conference. She noted that policymakers could have sufficient information at that time to decide to raise official rates. And, the committee could quickly schedule a press conference to discuss the decision.
We think the odds of that occurring are extremely low. Such a quick U-turn in the policy decision would certainly hurt the credibility of policymakers. But more important, a near-term rate hike would definitely be a surprise to the financial markets and trigger increased volatility— something that influenced the Fed’s decision to delay any rate move this month.
Are decisions truly data dependent?
Up to now, policymakers, especially Yellen, have argued that their decisions are data dependent. But the economic data has been generally strong recently, including numerous positive revisions—particularly for labor-market data and consumer spending. It seems to us that a data-dependent policy is only credible if you follow it, instead of making detours when the tough decisions are at hand.
We think policymakers are making a mistake similar to their decision not to taper their bond purchasing program in September 2013. That decision had been preceded by policymakers telegraphing a move to start slowing their asset purchase program, but they then surprised markets by delaying the tapering for another three months—owing to some soggy economic data and tightening financial conditions. In hindsight, that decision proved to be wrong, as the economic data was revised up and the economy soundly advanced 3.5% over the second half of 2013.
A similar scenario is likely to unfold again this time, especially if our above-consensus growth forecast is close to the mark. Yet this time, the jobless rate would probably be at or below 5%. And starting from a position of a near-zero federal funds rate, policymakers will need to play catch-up—something Yellen said she was trying to avoid.
By Joseph G. Carson, US Economist and Director, Global Economic Research, AB
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