Fed: A Hawkish Tilt

Published on October 28, 2015
SGH Insight
"We believe this October statement points to an FOMC majority, which includes Chair Janet Yellen, that is sticking to its stance the US economy is essentially “there” in warranting the start to a very gradual normalization of the policy rate. Prohibitive risks are being monitored but are not precluding a rate move, and while an FOMC first rate hike “at its next meeting” is not a foregone conclusion, we think the October statement indicates the burden of proof has sharply swung back against those Committee members arguing against a December rate move."
Market Validation
(Bloomberg 11/4/15) " -Treasury Two-Year Yields Set Four-Year High as Bets on Fed Climb - Probability of Fed rate increase next month climbs to 58%
- Yellen says December meeting is `live' if data support move
- Treasuries fell, pushing two-year yields to the highest since 2011, as Federal Reserve Chair Janet Yellen said she sees the economy as performing well, stoking speculation the central bank will raise its benchmark interest rate next month.

In testimony to U.S. lawmakers in Washington on Wednesday, Yellen said a December rate move would be a "live possibility" as long as data support an increase. Fed officials last month raised the prospect that the Fed’s first increase since 2006 would come in December."

It took us a second to realize the significance of the tweak in the third paragraph of this afternoon’s Federal Open Market Committee October meeting statement – we are slow readers – and the market seems to have needed a few minutes to latch on as well:

“In determining whether it will be appropriate to raise the target range at its next meeting , the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation.”

That is the money sentence.

*** We believe this October statement points to an FOMC majority, which includes Chair Janet Yellen, that is sticking to its stance the US economy is essentially “there” in warranting the start to a very gradual normalization of the policy rate. Prohibitive risks are being monitored but are not precluding a rate move, and while an FOMC first rate hike “at its next meeting” is not a foregone conclusion, we think the October statement indicates the burden of proof has sharply swung back against those Committee members arguing against a December rate move. ***

Other Key Statement Tweaks

As we had anticipated (SGH 10/26/15, “Fed: Halloween Reset”), the Committee also downgraded the September statement sentence that had highlighted the risks in the international outlook and replaced it with a more neutral “monitoring” of the risks: “The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring global economic and financial developments.”

That more upbeat tone was also threaded through the descriptive first paragraph on the current state of the economy: the Committee noted that economic activity continued to be “moderate,” upgraded the pace of household spending and business fixed investment to “solid,” and noted that housing was improving “further.” And while it is true they acknowledged the pace of job growth had “slowed,” they offset that with a key “nonetheless” before noting that labor market indicators continued to show the under-utilization of labor resources “has diminished since early this year.” This is not quite the “cumulative gains” we had thought could make its way into the statement, but it is close enough.

This should, in turn, color the way the market reads the data from here, on three fronts: one, the Committee will not need to see strongly higher net job creation in the two upcoming Nonfarm Payroll prints – 100,000 is the new 200,000 – two, they do not need to see (but would certainly welcome) firmer signs of either rising wage growth, or, finally, for higher core inflation. It is not a rebound in stronger jobs numbers they need to see, but rather the absence of either a rapidly slowing US jobs growth or a hard landing in growth abroad.

Fed Messaging from Here

As we also noted in our most recent report (SGH 10/26/15, “Fed: Halloween Reset”) we expect two themes may dominate the Fed messaging in the coming weeks: First, we think they will better frame their “data dependent” language to clarify their reaction function to the upcoming data by noting the lower hurdle they need to see in the levels of net job growth in the remaining two months that would underscore an economic growth essentially “good enough” for the long sought start to policy normalization. Second, they will stress that a start to policy normalization is not the same as a policy tightening and that policy will remain highly accommodative for a long time to come under its base case path of a very gradual pace of rate hikes.

A December meeting rate hike is not yet a foregone conclusion, say, in the way the May 2004 statement explicitly pointed to a June 2004 rate hike, but the statement today comes about as close as the Committee probably dared amid the uncertainty and above all a hugely skeptical market that will need much more time and clearer Fed messaging on how it is reading the data from here.

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