The Fed: Silent on September

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When Fed Chair Janet Yellen spoke in Cambridge, Mass. on 27 May, she outlined conditions to justify a rate hike: “The economy is continuing to improve … growth looks to be picking up,” she told a group of Harvard professors and alumni. “If that continues, and if the labor market continues to improve … it’s appropriate, and I’ve said this in the past I think, for the Fed to gradually and cautiously increase our overnight interest rate over time, and probably in the coming months.

Soon after, a very weak payroll report on 3 June and the pending vote for Brexit on 23 June caused Fed officials – or at least the Chair – to lose confidence in their outlook. After their meeting on June 14th and 15th, they backed away from signaling a rate hike would be appropriate “in coming months.”

Since then, though, U.S. economic data have been surprising on the upside – most notably with the gangbuster employment report on 8 July which indicated that 287,000 jobs had been created in June, with a three-month average of 147,000 jobs. That was well above the roughly 100,000 jobs per month (or less) the Fed itself estimates is the new normal for the economy given the slowdown in labor force growth.

So coming into the 27 July meeting, the question was not “Will the Fed hike?” That had been taken off the table with the publication of the minutes of the June meeting. But rather, “Will the Fed recognize the stronger economic data received since the June meeting and signal a desire to hike ‘in coming months’ – perhaps in September?” In other words, would the Fed acknowledge the May payroll report appears to have been a blip and that the post-Brexit reality had not been “the Lehman moment” some had predicted, implying that a rate hike would be justified given the criteria laid out by the Chair in May?

The Fed statement did acknowledge that “the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months.” The Fed also conceded that “economic activity has been expanding at a moderate rate,” a rate faster than the very slow growth of the first quarter. Finally, and of greatest interest, the Fed did acknowledge that “Near-term risks to the economic outlook have diminished.”

That said, the Federal Open Markets Committee (FOMC) continues to state, as it did in June, that “the Committee continues to closely monitor inflation indicators and global economic and financial developments.”
Fed says economy improving but offers no guidance.

So while the Fed now appears to be less worried than it was in June about the “near-term risks to the economic outlook” and to accept that ”labor market utilization” has increased in the context of moderate, at- or above-trend growth, it is not willing to signal to markets that a hike will be appropriate in “coming months” – let alone September.

So for now, the Yellen Fed has given up on “calendar guidance” but is unwilling – or unable – to replace it with outcome-based guidance, or really any guidance whatsoever. This is a Fed that prizes “optionality” above all else.

That appears to be working for now. But options have a positive price, which so far the Fed has not had to pay. This is a free lunch that won’t last forever.

By Dr. Richard Clarida, PIMCO Global Strategic Adviser

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