Fed: A Clearer Signal

Published on December 17, 2014

If there is any single takeaway from today’s Federal Open Market Committee, it is this definition of the new “patience” language introduced by Chair Janet Yellen in her opening remarks to the gathered press: “the committee considers it unlikely to begin the normalization process for at least the next couple of meetings.”

*** Chair Yellen was at pains to pitch the guidance tweaks as a mostly technical clean-up of aging language, signaling no change in the policy stance in that it means, well, pretty much the same thing as considerable time. But that is true only in a very narrow sense. The patience language of not moving before the next couple of meetings is indeed the same as a “considerable time” after the October end to the bond purchases. Such an affirmation amid the swirl of concerns over low inflation does mark a slightly more hawkish policy stance, which we continue to think is pointing to a June rates lift-off (SGH 12/11/14, “Fed: The Case for June”).

*** In other words, while the Fed’s policy path will be “data-dependent” (well, of course, when is it not?), in coupling the newly defined patience language of the statement guidance with the upgrade in the real growth projections and the near-dismissal of the near term “transitory” low inflation pressures, Chair Yellen has provided a clearer sense of the central bank’s reaction function to the incoming data: if the incoming data does indeed hue to the base case of the central tendency forecast, June for a Committee majority is the fulcrum around which the sooner or later language introduced in October rotates.

*** For all the endless handwringing and disinflationary gloom, Chair Yellen made it clear that the marking down in headline inflation will not preclude a lift-off in rates in 2015. While acknowledging the dis-inflationary pressures from abroad and the free-fall in oil prices, its spillover into core inflation will be limited and fading over time. Crucially, the price impact of the lower oil will be transitory. Instead, inflation is still expected to rise slowly as the job creation continues and pushes the unemployment rate to the bottom end of most estimates of its longer run levels.

*** And while yes the Fed will be keeping an eye on the various market measures of inflation expectations, the real economy surveys continue to carry the far greater weight in the Fed’s inflation assessments. And crucially, due to the lag in monetary policy, the Fed will not wait for core inflation to be back to its 2% inflation target, but will begin before moving off the zero lower bound as long as it remains confident core inflation is moving towards mandate-consistent levels over the forecast near horizon (SGH 10/3/14, “Fed: A “Patient” Reaction Function”).

*** On the most likely pace of the rate tightening trajectory, Chair Yellen made clear the one thing it won’t be is measured. “I certainly don’t want to encourage you to think that there will be a repeat of that,” she declared, adding that they can go at any meeting, not just the quarterly SEP/presser meetings. The FOMC assumes the trajectory will be a gradual one, with rates “below normal” for quite a while after achieving the twin mandates, and that there is every expectation of rates eventually reaching “historically normal levels” – so no secular stagnation in these corridors.

*** Chair Yellen also affirmed “the committee is not anticipating an overshoot of its 2% inflation objective,” which we believe testifies to the concerns over the “inertial inflation” we wrote about recently (SGH 12/11/14, “Fed: The Case for June”) and which we think points to both the need for an unusually long trajectory and a mid-2015 rates lift-off.

*** The 2015 blue dot rate plots were indeed nudged down a bit to a median 1.125% from 1.375%, which we also wrote was likely (SGH 12/16/14, “Fed: Wednesday’s Expectations”), and which was more about greater confidence in the forecast and the approaching real time of a lift-off than wariness over the outlook or concessions to the downward inflation pressure. Indeed, much of the downward movement came from hawks who, one assumes, are bit more realistic in their rate assumptions as the actual rate hike nears. But if the most hawkish and dovish dots are stripped out for a clearer picture of the core cluster of rate dots, that median is closer to the 1% where we think the target range for federal funds will be by the end of next year.

*** Real growth in 2015 was marked up — by quite a bit — to 2.3%-2.4% from 2.0%-2.2% but otherwise running in the rest of the forecast horizon along the same path, reaching a peak 2.6%-3% in 2016, the year most of the FOMC expected to achieve its mandate-consistent levels of unemployment and nearly to that for inflation. Indeed, the downward global and lower oil price pressures on headline inflation were acknowledged, with PCE pushed down sharply in 2015 to 1.2%-1.3% from 1.5%-1.7% in September. But the key core PCE was held constant with the same 1.5%-1.6% projection for 2015.

*** The three dissents would normally leap off the statement page, but on a closer look, they were three singular dissents, all for different, almost technical reasons, the same three again dissenting for the same reasons behind earlier dissents this year (not that there is any significance to it, but curiously, all three have already announced they will be leaving the FOMC next year or in early 2016). So in that sense, the rarity of three dissents look to signal little in terms of shaping the policy decisions coming through next year.

And finally, with some awkwardness, the FOMC resolved the great debate on statement forward guidance by splitting the difference; like King Solomon deciding on what to do with that baby, the FOMC opted to introduce the “patience” language while keeping the “considerable time” phrasing lingering for a bit longer in the statement, its past tense as a transitional hand-off to this next phase of policy normalization.

The guidance at first glance felt almost too clever by half, and it was as though the Committee was willing to look a tad indecisive, sowing just enough confusion to ensure a mixed market reaction for the thirty minutes before Chair Yellen could sit down before the press to make her pitch. And for all of her dislike of committing to doing the press conferences after every meeting, it has to be said she handled this one well, clarifying almost all of the Committee’s views and expectations going into this next crucial phase of policy normalization.

Back to list