Mind Your Language!

The Federal Open Market Committee is widely expected to take another trip to Taper Town on Wednesday, reducing the monthly pace of asset purchases by another $10 billion, one step closer to ending the program in late October. The more interesting issue is whether we’ll see any change in the Fed’s forward guidance on short-term interest rates – specifically, whether the FOMC will jettison the “considerable time” language. Probably not, but there will be plenty of other points of interest contained in Fed officials’ revised economic projections and in Janet Yellen’s post-meeting press conference.

Two years ago, the FOMC began its current Large-Scale Asset Purchase program (LSAP, but more commonly referred to as “QE3”). As it did, the FOMC said it expected that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.” In its forward guidance on short-term interest rates, the FOMC indicated that “exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015.” That time frame was pushed out from the previous policy statement (“at least through late 2014”). At the December 2012 meeting, the FOMC shifted to economic thresholds for its forward guidance; short-term rates would remain exceptionally low as long as the unemployment rate was above 6.5%, the one-year-ahead inflation outlook was less than 2.5%, and inflation expectations remained “well anchored.” As the unemployment rate drifted toward 6.5%, the Fed had to rethink this guidance. At the March 19 policy meeting this year, the FOMC indicated that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.” That language was carried forward in the policy statements in April, June, and July. Some Fed observers think it’s time for a change.

The “considerable time” phrase echoes similar language used ahead of the previous tightening cycle in 2003, when the FOMC indicated that it expected to keep short-term rates low (the federal funds target was 1% at the time) for “a considerable period.” That phrase was included in four policy statements in late 2003, but did not appear in the January 2004 statement. The Fed began raising the federal funds rate target in June (at which point, policymakers indicated that rate hikes were expected to come “at a measured pace”).

At this week’s policy meeting, Fed officials will update their projections of growth, unemployment, and inflation. These forecasts also include expectations of the federal funds target rate at the end of the next few years. This week, the Fed’s Summary of Economic Projections (SEP) will extend these forecasts to 2017. In her March 19 press conference, Chair Yellen cautioned against reading too much into the dots (“I would simply warn you that these dots are going to move up and down over time a little bit this way or that”). That’s true, but there is important information in those projections.

In June, as in previous projections, the federal funds rate forecasts of the Fed governors and district bank presidents were all over the map. All but one Fed official expected that the federal funds rate target would not be raised this year. All but three expected rates to begin rising sometime in 2015. However, there was a wide range for where the target was expected to be at the end of 2015 and 2016. If one assumes that rate hikes will be made in “measured steps” of 25 basis points, the individual year-end forecasts for 2015 would imply an equally wide range for the expected date of the first rate hike (three for July, three for September, one each for March, April, June, October, and December, with three for 2016). One thing to watch for in the September SEP: will the individual federal funds rate forecasts bunch up a little more around specific year-end targets (and implicitly, dates for the first rate hike)?

Some Fed officials have suggested that it’s time to jettison the “considerable time” language and tie the rise in rates back to the economic data. Fat chance. Inflation hawks gotta squawk, but the inflationistas are a small minority at the Fed. Still, it’s not unusual for the majority to tweak the language of the policy statement slightly to put the hawks a little more at ease.

Fed officials know that short-term interest rates will have to be raised at some point, but they don’t want financial market participants to misinterpret their intentions. The bottom line remains: monetary policy in 2015 will depend on the evolution of the economy in the second half of 2014.

© Raymond James

© Raymond James

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