Fed Funds Rate: Where’s the Slack? by Dutch Book, Stone Street Advisors

This June, the Fed’s most reactionary member, and noted hand talking enthusiast, James Bullard gave what I found to be one of the most reasonable presentation on FOMC policy in years.  It was titled ‘How Far Is the FOMC from Its Goals?’ and if you have not seen it please do give it a look here. In it he outlined a simple formula to quantify how close the Fed is to threading the needle on policy based on absolute distances from the inflation and unemployment targets levels.

The data from that presentation was from April.  I thought it worthwhile to update it since, for reasons I do not understand, the market is currently pricing Fed Funds rate hikes even further out today than they were then.

Fed Funds Rate

The Fed is currently closer to its dual mandate targets than 89% of the historical data and closer than any point in since 2004. This is a noted improvement from June when it was closer than 75% of readings.

It is important to recognize that when your target has multiple inputs and data is constantly in flux you are not likely to be precisely at your target often.  As a matter of fact, the Fed has not hit both targets in any month since 1960 when they started the PCE index.

The Fed targets are symmetrical so it is worth remembering when economists like Krugman, Stevenson, & Wolfers point out the Fed is “missing on both mandates” today, that it strictly a function of their political viewpoints.  The Fed is always missing the mandates but the goal is to set the best policy for 6-12 months from now.

In all previous examples the Fed has changed course on rates within three months of being this close to targets, which is one of the many reasons I maintain the view I’ve expressed for the past 20 months.  First hike Q1 2015 and continuing at 200 bps a year.