Divided Fed scrambles message on rates

Posted on September 13, 2016

Janet Yellen, chair of the U.S. Federal Reserve, speaks during a House Financial Services Committee hearing in Washington, D.C., U.S., on Wednesday, June 22, 2016. By offering a subtle change to her outlook from less than a week ago, Yellen on Tuesday before the Senate Banking Committee pushed the prospect of additional interest rate increases further into the future. Photographer: Andrew Harrer/Bloomberg©Bloomberg

When she addressed fellow central bankers in the mountains of Wyoming last month, Janet Yellen, the Federal Reserve chair, said the case for a second increase in short-term interest rates was strengthening. The words prompted some analysts to predict that a move could come as soon as the Fed’s September 21 meeting.

Less than three weeks later, however, sharp divisions among Fed policymakers and a muted set of August jobs numbers have left the markets putting low odds on a near-term increase and placed the impetus on Ms Yellen to give a clearer sense of the direction of policy when the central bank meets next week.

    The final two public messages from the Fed’s powerful board of governors in recent days have come from doves — Lael Brainard and Daniel Tarullo — who both suggested that inflation remains too muted to merit a move. Meanwhile, other policymakers including John Williams of the San Francisco Fed are openly fretting about the risk of allowing the US economy to overheat.

    The upshot is that if the Fed does pass on a rate increase this month, policymakers will probably want to send a signal that a move is on the table by the end of the year. Complicating that communications job is the possibility that the Fed’s longer-term forecasts for interest rates are cut yet again on Wednesday next week — even as the central bank seeks to keep alive the possibility of a near-term rate rise.

    “Yellen has a difficult communications challenge,” said Louis Crandall, chief economist at Wrightson ICAP. “You don’t want to create the sense that the Fed will never tighten.”

    Back in December, the median estimate from Fed policymakers was for four interest-rate increases over the course of 2016. It has not turned out that way. Volatile markets in the early months of the year derailed any prospect of a March move, while an apparent hiatus in hiring in May followed by the UK’s vote in June to leave the EU once again prevented the US central bank from lifting rates.

    At the same time, Fed policymakers have been coming around to the view that the US economy may be stuck in a slow-growth, low inflation paradigm that will last longer than they thought. This has prompted estimates for the so-called neutral rate of interest — the rate consistent with a stable economy — to remain low. The rethink could be reflected in lower estimates for the long-term federal funds rate next week. As things stand, the median projection stands at 3 per cent.

    Fed should not rush to raise rates, says Brainard

    Lael Brainard, center, governor of the Board of Governors of the Federal Reserve System, speaks with activists Angela McCall, right, with MORE, Missourians Organizing for Reform and Empowerment, and Kendra Brooks, of Action United of Philadelphia, following a forum before the opening night reception at the annual invitation-only conference of central bankers from around the world at Jackson Lake Lodge in Grand Teton National Park, north of Jackson Hole, Wyo., Thursday, Aug. 25, 2016. (AP Photo/Brennan Linsley)

    Already low expectations of a September increase fall further after policymaker’s cautious comments

    Communications in recent weeks have caused confusion among some investors.

    As recently as the end of last month Ms Yellen said in a speech at the Jackson Hole, Wyoming, symposium of central bankers that the moment for a second increase in short-term rates was drawing nearer because the US was nearing the Fed’s twin goals of full employment and price stability — a message that was reinforced by Stanley Fischer, her deputy, at the same gathering.

    Yet the Fed has just gone into its pre-meeting blackout period with the odds of a move in September seen at just 22 per cent, according to Bloomberg data.

    If the central bank were to lift rates in that scenario it could cause a violent reaction in markets. The market gyrations in recent days after the European Central Bank gave ambiguous signals about its own stimulus plans highlighted the risks.

    “I would be quite surprised if they raised next week,” said Michael Feroli, US economist at JPMorgan Chase in New York. “They haven’t done the work to get the market on their side and you could have a pretty messy day if that happened.”

    Some analysts say they have struggled to interpret Ms Yellen’s message. Economists led by Jan Hatzius at Goldman Sachs on Tuesday cut their odds on a September rate increase even though they argued the economy was performing in line with the policy path the Federal Open Market Committee has previously published.

    The economists said they had believed Ms Yellen was leaning towards a September rise, based on her comments at Jackson Hole and the two-increase baseline forecast in the Fed’s June interest rate projections.

    “The lack of a co-ordinated signal from Fed leadership in recent days suggests this is no longer the case — or was never the case to begin with — and that Chair Yellen herself favours standing pat,” they wrote.

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