Leave the Door Open
There is little reason to expect the Fed will adjust its policy rate at this October FOMC meeting. If economic output since the September FOMC meeting had been slightly more robust and if the late-August financial markets disruption had more immediately and fully repaired, the October FOMC meeting would have presented a good opportunity for the Fed to begin removing monetary policy accommodation. As it is, Fed officials are likely to collectively assume there is more to be gained from assessing for a bit longer the potential fallout from slower global growth and a possible step-down in the pace of domestic job growth.
While the markets are currently pricing a greater chance for monetary policy normalization to begin in 2016, my analysis still suggests the December meeting is a better likelihood. Before the December, 2013 FOMC meeting few, for a variety of reasons, believed the Fed would change its stance on security purchases. I argued before that meeting that the Fed would announce a reduction of purchases to begin in January (2014), describing a pace for the elimination of purchases by the 4th quarter 2014 (FOMC Report December 17-18, 2013). Market participants may again be mistakenly expecting that the Fed will wait till ‘next year’ to move forward.
However, at the September FOMC meeting just past, a large majority of FOMC participants (13 of 17) indicated that they expected the policy rate to be higher at year-end. While employment growth has continued, though at a slower pace – possibly as a result of some slack already having been removed from the labor market, other signs of moderation are expected to keep a majority of voters from electing to move in October.
A reduction in output has been accompanied by a reduction in inventory levels that may prompt some re-shelving of inventories in Q4, elevating growth above potential once again. Otherwise, the housing market continues to improve and consumer spending has held up well.
In describing economic growth in the statement following the meeting, the Fed may choose to indicate that the pace has been ‘modest’ rather than ‘moderate’ as they had in September. I suspect they will choose to continue to use the ‘moderate’ description and possibly note that the slowing in employment growth is consistent with the removal of slack in labor markets thus far and that the cumulative improvement has been encouraging. Otherwise, the use of the term ‘modest’ to describe growth might suggest there is a lesser chance for a December policy response. The Fed looses nothing in keeping its options open for December.
In further acknowledging the cumulative gains in labor market conditions, the Fed might change their guidance language. Instead of indicating ‘when it has seen some further improvement in the labor market…’, it may adjust to ‘when it sees continued improvement in the labor market…’ This does not change the intent of the guidance, but it could allow for some take-up from an otherwise disappointing note on lackluster global demand. Leaving the door open for a policy response this year, the Feds job of readying economic agents in December, if the data warrants, would be easier if the Fed does not overemphasize the implications of still adjusting global conditions.