FOMC Meeting: A Creature Is Stirring by Zach Pandl, ColumbiaManagement
- Last week’s news suggests that the center of the FOMC continues to see interest rate hikes in the middle of next year as most appropriate.
- December 17 looks like a natural time to begin signaling the possibility of rate hikes to financial markets—an eventuality for which bond investors do not look prepared.
- There are risks to making this change, but we suspect that Fed officials would favor a small hawkish surprise now over a large hawkish surprise later.
The November jobs report offered more evidence that U.S. growth has shifted up a gear. We are particularly encouraged that the gains in payroll employment were corroborated by other measures of real activity, such as surveys of business and consumer sentiment. Our proprietary indicator of U.S. growth has now increased at an annualized rate of at least 3% for nine consecutive months (Exhibit 1).
Exhibit 1: Persistent above-trend growth (% annualized rate)
Besides the jobs numbers, communication from the Federal Reserve last week also affected risks around the policy outlook. Four news items caught our attention:
1. Dudley continues to back mid-2015 liftoff date. New York Fed President Dudley said in a speech last Monday that a first rate hike in mid-2015 seemed “reasonable”—an addition to his remarks on November 13 which were otherwise very similar. He added that inflation expectations “still seem well-anchored”—despite some wobbles in market- and survey-based measures recently. Thus, President Dudley’s speech was noteworthy in that it contained very few changes: he signaled that the Fed remains on a similar course for policy, at the same time that market views have skewed toward later rate hikes.
2. Fischer hints “considerable time” open for debate; Fed leadership has centrist views. Fed Vice Chair Stanley Fischer’s remarks to WSJ and CFR events offered a number of clues on how Fed officials are processing incoming information. Most importantly, his response to a question on the “considerable time” language in the FOMC statement suggested that the internal discussion around this topic was not finalized (for the time being) in October—which we had thought after reading the minutes from that meeting. Here is what Mr. Fischer had to say:
“I think you saw in the minutes of the last meeting there was some discussion of that, so it’s clear that we are closer to getting rid of that then we were a few months ago. But it wouldn’t be appropriate for me to give you a guess as to what my colleagues and I are going to do at the next meeting … we’re not going to suddenly stop that [i.e. “considerable time”] and not say anything … as the likely date nears, or as the likely situation nears, we will use different words, I assume, to describe the situation.”
His comments included several other notable points on the Fed’s current worldview.
On the appropriate monetary response to the decline in oil prices:
“This is a supply shock, and you treat them differently than a shock that’s caused by … demand”
On the state of the labor market:
“The really big fact that I think about with the labor market much of the time is the fact that the unemployment rate has come down much more rapidly than was expected as little as a year and a half ago … [broader measures] too have come down more recently; U6 has come down quite rapidly as well.”
And on the lack of a pickup in wage inflation:
“It is often the case in economics that you’re waiting to see a phenomenon. Somebody did something that should have produced X, and there’s no X on the horizon. My experience has typically been that if you wait another six months, or longer, X will suddenly make a belated appearance.”
These are important counterpoints to the increasingly dovish narrative among market participants. Fischer chose to highlight the decline in labor market slack (rather than its abundance), said that wages would likely pick up with a lag, and made clear he read the drop in oil prices as a supply shock—something that monetary policy should “treat differently”. This does not sound like a central banker leaning towards a later start date for rate hikes.
3. Evans only conditionally backs “considerable time”. In an interview with the New York Times, Chicago Fed President Evans supported the continued use of the “considerable time” language, but conditioned his response on his out-of-consensus policy view. Specifically, when asked whether it was now time to revise the phrase, he said:
“I think appropriate monetary policy would keep the funds rate where it is until the first quarter of 2016. “Considerable time” seems to describe that perfectly fine. I don’t feel it’s important to change the public’s thinking on that, so I don’t see a need.”
Evans’ elliptical response may suggest that under the consensus view—which seems to favor a mid-2015 rate hike—the current statement language may no longer be “perfectly fine”.
4. Fed staff says optimal control rules call for early-15 rate hikes. Finally, in a post to the Board’s FEDS Notes blog, Fed staffers presented an update to the “optimal control” (OC) simulations described by then-governor Yellen in 2012 (see here for background). At the time they were first presented, these projections surprised markets because they called for rate hikes only in early 2016. However, due to the larger-than-expected decline in unemployment since that time, updated forecasts from these models call for rate hikes beginning in Q1 2015 (Exhibit 2). For a variety of reasons we still believe the first rate hike will be slightly later than that (arriving at the June 2015 FOMC meeting), but the projections nonetheless highlight that standard policy rules envision the Fed beginning its exit in the very near future.
Exhibit 2: Updated “optimal control” calls for rate hikes in Q1 2015
What does all this mean for the upcoming FOMC meeting? In our view, it means that the “considerable time” language—which has been in the statement in some form since September 2012—is likely to be revised. Last week’s news suggests the center of the FOMC continues to see rate hikes in the middle of next year as most appropriate, and has not been swayed by recent developments in commodity markets, inflation breakevens or foreign growth. Plus, we see few signs that key officials are adamant about keeping the language in place. Therefore, with no press conference at the January 2015 FOMC meeting, the December 17 announcement looks like a natural time to begin signaling the possibility of rate hikes to financial markets—an eventuality for which bond investors do not look prepared. There are risks to making this change, but we suspect that Fed officials would favor a small hawkish surprise now over a large hawkish surprise later.