Fed's Getting Anxious About Interest Rate "Liftoff"
IN THIS ISSUE:
1. FOMC Minutes – Fed Looking For an Early Exit?
2. Some FOMC Members Want an Earlier Liftoff
3. Yellen’s Jackson Hole Speech – More Data Needed
4. Bottom Line: Yellen in No Hurry to Raise Rates
While I have been a Fed watcher for over 30 years, rarely have I seen as much media angst over the central bank’s next move as we are seeing today. We all know that the Fed is going to raise short-term interest rates at some point. We expect the Fed to “normalize” interest rates slowly in measured steps over the next few years. The main question is, when does this process begin?
The other question is, what effect will the eventual interest rate increases have on the stock and bond markets and the economy? While the Fed has made it clear that it intends to end its “quantitative easing” (QE) policy by late October, and that it will start to raise rates sometime next year, stocks and bonds have been on an upward tear all year. Stocks are at record highs, and bond prices have risen when most forecasters expected them to go down.
When Janet Yellen took over as Fed Chair earlier this year, she suggested that the Fed would not begin to raise short-term rates until at least six months after QE ends. Most analysts assumed that meant no interest rate hike until at least April or May of next year, or even later. However, the minutes from the July 29-30 Fed policy meeting released last week suggested that several FOMC members think a rate hike should occur sooner.
This revelation (dare we call it that) set off quite the buzz among financial writers over the last week. The concern is that if the Fed raises interest rates too early, that could choke off the feeble economic recovery. Yet while some financial analysts sounded alarm bells over the possibility that the Fed’s interest rate hike might happen sooner than expected, the markets seemingly could care less. That’s part of what we’ll talk about today.
FOMC Minutes – Fed Looking For an Early Exit?
As noted above, the minutes from the July 29-30 Fed Open Market Committee meeting were released last Wednesday and made it clear that a growing number of FOMC members are arguing that interest rates need to increase sooner rather than later. The Fed’s own term for the eventual increase in short-term rates is“liftoff.”
Philadelphia Federal Reserve President Charles Plosser, a voting member this year, heightened the pressure on the FOMC to raise the Fed Funds rate more quickly by dissenting from the July 30 FOMC policy statement’s call for a continued “considerable period” of near zero short-term interest rates. While he was the only member to vote no, he is not alone in his views.
The mere hint that the Fed might raise interest rates sooner than previously assumed set off a wave of articles in the financial media. While everyone had to put their particular spin on it, the message was essentially the same: liftoff may be coming sooner rather than later. But before we come to that conclusion, let’s put it into perspective.
First off, it’s late August. With the exception of ISIS, Ferguson, MO and President Obama golfing too much, not much is happening. Journalists were hungry for a story, so the financial media jumped on the latest Fed minutes from the July 29-30 policy meeting. But was it an overreaction? I think so. Here’s the story line.
The July FOMC minutes revealed considerable discussion about the timing of the first Fed Funds rate hike and the eventual “normalization” of interest rates in general. Why this is notable I don’t know. It’s not the first time the FOMC has had such discussions. Furthermore, with QE on track to end in just two months, it seems only natural to me that the Fed would be discussing the eventual liftoff.
Here is a brief summary of the July FOMC meeting minutes. The Fed acknowledged that the US economy rebounded in the 2Q (+4.0% initial estimate) from the decline in the 1Q. Likewise, labor market conditions improved since the June Committee meeting. However, the number of people working part-time because they couldn’t find full-time work continued to go up.
This fact was troubling for Chair Yellen and other members of the Committee. There was a discussion about how much “slack” remains in the labor market and how to measure it. They noted that while the official unemployment rate has fallen more than expected, most members remained concerned with the long-term unemployed and those working part-time for economic reasons.
Fed staff noted that consumer spending increased in the 2Q. In particular, gains in equity values and home prices boosted household net worth, and real disposable personal income continued to rise in the 2Q. The housing market was a mixed bag but was still better than in the 1Q and home prices continued to rise. Manufacturing and factory output advanced in the 2Q, as did real private sector expenditures for business equipment.
Offsetting these positive developments was a decrease in real federal spending and a moderate slowdown in net exports. Overall, however, the economic outlook was considered quite positive, especially compared to the 1Q when GDP fell 2.1%. Fed staff forecast the economy to grow solidly during the second half of the year.
Regarding inflation, the members acknowledged that certain price measures had increased modestly in recent months; however, inflation as measured by the Fed was still below the FOMC’s target.
Some FOMC Members Want an Earlier Liftoff
It was in this positive context that some Committee members chose to discuss the possibility of raising the Fed Funds rate before the middle of next year. Most agreed that labor market conditions and inflation had moved closer to the Committee’s objectives in recent months, and most anticipated that progress toward those goals would continue. And then came perhaps the most surprising passage in the minutes:
Moreover, many participants noted that if convergence toward the Committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.
Indeed, some participants viewed the actual and expected progress toward the Committee’s goals as sufficient to call for a relatively prompt move toward reducing policy accommodation to avoid overshooting the Committee’s unemployment and inflation objectives over the medium-term.
These participants were increasingly uncomfortable with the Committee’s forward guidance. In their view, the guidance suggested a later initial increase in the target federal funds rate as well as lower future levels of the funds rate than they judged likely to be appropriate. They suggested that the guidance should more clearly communicate how policy-setting would respond to the evolution of economic data.
[All emphasis mine.]
When the minutes refer to “… removing policy accommodation...” that is code for raising the Fed Funds rate. And in this case, raising it prior to the middle of next year. Apparently, some of the more hawkish members of the Fed insisted that this language be included, among them was Philadelphia Fed President Charles Plosser.
In any event, many in the financial media seemed shocked to learn last Wednesday that some members of the FOMC want the Fed Funds rate raised sooner rather than later. Yet while the language is new, it’s not that different. Former Fed Chairman Ben Bernanke said on numerous occasions before he retired that the timing of rate increases would depend almost entirely on the economy, and that could mean an earlier or later end to QE.
Nonetheless, that didn’t stop financial writers such as Paul Krugman of the New York Times and others from blasting the hawks on the FOMC for wanting to hike the Fed Funds rate sooner than mid-next year.
Funny thing, though – the markets paid hardly any attention to the new language in the Fed minutes. The S&P 500 soared to yet another new record high by Friday. Treasury bonds, which had flinched a little earlier this month, also closed stronger by the end of the week.
Yellen’s Jackson Hole Speech – More Data Needed
Fed Chair Janet Yellen delivered the keynote speech at the Fed’s annual monetary gathering in Jackson Hole, WY last Friday. Given the new language in the July 29-30 Fed minutes, even more attention was paid to Ms. Yellen’s speech – her first at this gathering since she became Fed Chair.
While Yellen admitted that the economy has improved since the 1Q, and that most of the trends in the labor markets are improving, she thinks it’s too early to start raising the key Fed Funds rate. In her remarks, Yellen said deciding when she’ll be satisfied with the progress in the labor market won’t be easy to determine.
“The labor market has yet to fully recover,” Yellen said in her speech at the Kansas City Fed’s annual conference. While the five-year recovery has put more Americans back to work, “a key challenge is to assess just how far the economy now stands from attainment of its maximum employment goal.”
Her comments were consistent with the minutes of the July 29-30 FOMC meeting, which showed officials growing more aware that the job market looks healthier. She said policy makers will have to consider a “wide range” of indicators to make that assessment, adding that there’s “no simple recipe” for deciding when to raise rates for the first time since 2006.
Ms. Yellen again voiced her concerns about the number of Americans working part-time jobs because they can’t find full-time work, as well as the number of long-term unemployed.
“As the recovery progresses, assessments of the degree of remaining slack in the labor market need to become more nuanced because of considerable uncertainty about the level of employment consistent with the Federal Reserve’s dual mandate.” That’s Fed-speak for we may not know the exact right time to raise the Fed Funds rate.
“Accordingly, the reformulated forward guidance reaffirms the FOMC’s view that policy decisions will not be based on any single indicator, but will instead take into account a wide range of information on the labor market, as well as inflation and financial developments.” That’s Fed-speak for we’re gonna work very hard to try and get this right.
Bottom Line: Yellen in No Hurry to Raise Rates
Despite all the hoopla last week about the Fed raising rates sooner than expected, Janet Yellen is in no hurry to make the first move, and a majority of the voting members on the FOMC agrees with her that we need to see more data.
Could the first rate hike come as early as the March 19-20 FOMC meeting next year? Depends on the data. Might the first rate hike not come until the June 18-19 meeting or the July 30-31 meeting? Depends on the data.
What we do know is that the Fed has told us its target for the Fed Funds rate is 1.13% by the end 2015 and2.5% by the end of 2016. As for exactly when the first rate increase happens, your guess may be as good as mine. But I don’t think we’ll see a Fed Funds rate hike this year.
Very best regards,
Gary D. Halbert
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