The FOMC will refrain from policy rate action at this July 2016 meeting. The statement following the meeting will highlight improving economic conditions, but that language will not be forceful enough to encourage economic agents to price as much as a 50% chance for a September rate hike. To the extent language on improving domestic economic conditions might by itself sway market participants toward pricing in too great a chance for a September policy response, reference to global conditions will be used to offset such impulses.
Financial Market Stability Not Steady Enough:
Global bond yields swooned following a near universal call by central bankers in particular and government officials more generally that uncertainty was at a higher plane. By inference therefore, the ability for governing bodies to make appropriate, forward looking decisions was assumed to have been curtailed. One might envision such heretofore decision makers sitting on their hands in wide-eyed amazement, hopeful some answers come to them that don’t also carry any needed additional qualification.
We have of course always lived in uncertain times. The adjustments we make are designed to put us back to the path we expect aligns us with our longer run goals. And though the balls currently in air may differ in color and quantity than the juggler is accustomed, it is still the same art he professes to practice. Juggle on Yellen. Juggle on Draghi. Juggle on Carney.
In my April FOMC Report, financial market stability was noted as of paramount importance; allowing ‘the Fed some level of confidence that they might provide economic agents some policy path for the return to more normal policy rates.’ Further, financial market stability would be self-supportive of greater levels of risk tolerance by economic agents as baseline economic growth improved with spending and investment. Finally, some support to economic growth would be expected to accompany a greater understanding of monetary policy intent even if that objective was toward modestly higher policy rates.
Financial market stability however, has not been steady enough for the Fed to move forward with policy normalization at the July FOMC meeting. Instead, there was a violent jolt to an otherwise quieting market when the U.K. ‘Leave’ vote was registered. Market participants initially reacted to the news as if a ‘black swan’ had just been spotted. Adjustments since that immediate response have proven much more subtle and supportive of additional risk tolerance.
Financial market stability, to the extent seen over the last month, has been accompanied by more constructive economic data. Since the Fed met in June, nearly every barometer of domestic economic activity has shown modest positive surprise. Were it not for the interruption to financial market stability brought about by the unexpected UK vote, the Fed might have been ready to raise rates in July. Instead, following the UK vote and in part too because of the surprisingly soft May employment data, economic agents pushed the pricing of any further Fed accommodation removal well into next year.
As it is now, with the aforementioned tempered financial conditions and supportive domestic economic data, the door may be opened at the July FOMC meeting for a Fed policy move in September. Continued economic gains and financial market calm will be required however before a September rate response can be put squarely on the table.
Fed View of Likely Path:
We may gain some sense of how interested the center of the committee is in raising rates as soon as possible by what they choose to emphasize in the statement. The most recent labor report as well as retail sales were a measure above what was seen prior to the June FOMC meeting. Inflation too has moved up modestly. The Fed could choose to emphasize domestic growth, inflation or global conditions. If the Fed wants to ready the market for a policy response initiated at the earliest convenience, without promising one, they are more likely to emphasize the recovering economic data rather than improvement in inflation. By doing so, they would be pointing toward a longer standing condition. While the right domestic ingredients for modestly increasing inflation exist, evidence of those conditions being expressed is not long lasting enough to be considered a trend.
The Jackson Hole Option:
Last year, Fed Chair Yellen may have thought that the annual Jackson Hole Symposium was becoming too important a staging area for new monetary policy direction and thus made herself unavailable for that confab, which as it turned out came only months before the Fed raised the policy rate for the first time in nearly a decade. This time around, Chair Yellen is a scheduled speaker, giving her the opportunity to provide some further guidance on policy intent.
At the risk of elevating the status of the Jackson Hole Symposium, but with some interest in raising rates by the end of the year, the FOMC may wish to downplay rate hike prospects in the July FOMC statement. That would reduce the chances for the market pricing too strong a reaction while leaving the Jackson Hole confab available as tool for further guidance should subsequent economic data allow.
While financial market stability has not been long lasting enough to allow a rate response at this stage, referencing an improvement in economic data rather than inflation would leave the door open for a later-year rate hike that includes September as a possibility. The FOMC does not need to be too forceful in guiding economic agents toward growing prospects for a rate hike because it can use the Jackson Hole Symposium in late-August to, if necessary, provide updated policy intent.