Fed: An Option Just Exercised

Published on July 30, 2014

The basic thrust of a more upbeat (and a modestly more hawkish) tone to the economic outlook in today’s statement by the Federal Open Market Committee fit well, almost too well, into our expectations laid out last week (see SGH 7/24/14, “Fed: Calibrating the Guidance for Lift-off”). The timing of a dissent, and by Philadelphia’s Charles Plosser no less, is a bit more surprising, and interesting.

*** We wrote last week of an option being written by Chair Yellen in her Humphrey Hawkins testimony to adjust the guidance come September if the data continue to point to an economy clearly in recovery. That option just got exercised today rather than later and, short of the data turning south, means it will be difficult now for the FOMC to back down from major changes in the guidance when they next meet in September. ***

Compromise or Consensus?

First, on the tweaks to the descriptive paragraphs of the statement: as expected, inflation has moved “somewhat closer” to the longer-run objective and the risks of persistent low inflation have “diminished somewhat,” while the overall risks to the economic outlook are “nearly balanced.” The further improvement in the labor market was likewise duly noted.

But then there was that insertion of the dovish sentence that “a range of labor market indicators suggests that there remains significant underutilization of labor resources.” While certainly true, and probably needed to qualify or soften the upgrade to the labor and inflation language, it has that hasty “compromise by Committee” feel to it rather than a more balanced craftsmanship by consensus. 

And that sense of a meeting a bit more contentious than what would be expected at this point rings especially true in the dissent lodged by Plosser. As we noted in our report last week, with the more dovish leaning looking by the fall to be much more open to the possibility of a rate hike in the middle of 2015 if the recovery continues as expected (see SGH 7/24/14, “Fed: Calibrating the Guidance for Lift-off”), our sense was that the threat of a dissent was going to be held until September, as it would be more powerful than an actual dissent in the inevitable debate looming over how aggressively to adjust the guidance.

There is nevertheless a not entirely small faction becoming a bit anxious as we noted last week that it would be prudent to start “repositioning” the guidance, including the “considerable period” language, to better reflect the tilt in the balance of risks to the upside if the data continues on its current course. That Plosser instead opted to exercise his dissent in July rather than threaten to do so in September means that debate is already well underway.

And that the dissent was specifically aimed at a time commitment that is no longer valid in light of the steady gains towards the Fed’s twin mandates also suggests a desire to acknowledge the optionality for some members for hiking perhaps even earlier than June next year.

What’s more, in not joining Plosser in today’s dissent, Dallas Fed President Richard Fisher becomes something of a “silent second dissenter,” which only adds to the potency of threatened dissents come September. And in the process, it quickens the pace of the FOMC’s slow affirmation of a “turn” to thinking more explicitly on the timing to a rates lift-off that may in turn make market expectations just that bit more difficult to manage from here.

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