Yesterday’s Wall Street Journal highlighted a supposed divergence between the market’s projection of two FOMC rate hikes this year, based on federal funds futures prices, and the Journal’s reading of the minutes of the December FOMC meeting that the Committee had pencilled in four rate hikes this year. The Journal supported that view by referring to recent supporting statements by Governor Fischer and Presidents Mester and Williams. However, a careful reading of Wednesday’s FOMC minutes reveals numerous instances of the words caution and gradual used to characterize the likely pace of further rate moves. In fact, the minutes use the word gradual six times in describing the expected adjustments in the Committee’s policy stance. Of course, gradual could refer either to the number of rate hikes or, as some have suggested, to moves in increments smaller than 25 basis points, but the latter would imply a degree of precision in the calibration of policy that presently is hard to justify.
It is worth noting that the Committee also fell back on now tired language to preserve its policy options noting “that the appropriate path for the federal funds rate would depend upon the economic outlook as informed by incoming data.” This statement was followed by an expression of concern about the low rate of inflation relative to target, along with risks and uncertainties concerning the inflation outlook. Indeed, the Committee explained that “the timing and size of future adjustments to the target rate … will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments” (my emphasis).
The Committee’s cautious statements about its policy path were made before the financial market turmoil and adverse information on the international outlook that we have experienced since trading began this year. Moreover, the inflation outlook certainly hasn’t improved with the further drop in oil prices – prices that clearly have not yet stabilized as the Committee assumed they would. For these reasons neither the market turmoil nor the oil price declines are consistent with any movement of the policy rate at the Committee’s January meeting, which is now only three weeks away. Furthermore, we have argued in a previous commentary that the flow of data available to the committee, especially on GDP, will not provide much useful information on the progress of the real economy in 2016 until the FOMC’s June meeting and then not again until its November meeting. Up until then, the Committee will only have stale data on 2015 Q3 and Q4 GDP – data generated before the FOMC’s December rate hike.
Certainly, the problems in China, the disruptions in the Middle East, the slowdown in Latin American countries, and the sluggish progress of the recovery in Europe do not suggest a climate in which financial-market volatility will abate anytime soon. In view of what is happening in world markets, the FOMC’s risk management approach to policy implies a cautious path that avoids increasing the risks to a growing and stable US economy. Hence, FOMC participants are not likely to rush to raise rates under such circumstances and risk a potential economic slowdown in the US. To be sure, labor markets are improving, but inflation is far from the Committee’s preferred rate, so why should the FOMC proceed on a path that might be inconsistent with what is presently happening in the rest of the world? For these reasons, we continue to see that the path for the FOMC’s policy rate in 2016 is tilted towards only two moves, which is consistent with market expectations rather than with the more aggressive posture posited by the WSJ and others.