Has Fed turned hawkish or did Yellen misspeak?
Although not much has changed in the economy, the US central bank sees rates rising faster
The Federal Reserve is telling us that not much has changed in the economy in the United States except rates are going to rise faster.
That is either growing hawkishness or a communications flub by Fed chairman Janet Yellen in her first Federal Open Market Committee press conference.
Wednesday's FOMC announcement did not change much in terms of the Fed's economic outlook. The employment outlook is ever so slightly more positive, but forecasts for gross domestic product this year were taken down a modest peg.
There is a slight weakening. Other than that, the committee does not appear to be expecting much difference in the economy relative to the outlook in December. Things seem a bit weaker than January, but bad weather obscures the true state.
"You have to read this statement as risk off," Steven Englander, a strategist at Citigroup, said in a note to clients. "Other than the very short-term bounce from the bad weather of this winter, supply-side projections are weaker, not stronger, but rates projections are higher."
According to the Fed's projections, the fed funds rate can be higher than it thought in December.
The median projection by FOMC officials is for a rate at the end of 2015 of 1 per cent, as against 0.75 per cent in December. Rates at the end of 2016 are seen at 2.25 per cent, up 50 basis points compared with December's forecasts.
If you ask me, an economy that is getting stronger at the same languid rate but is seeing interest rates rising faster is one seeing real tightening in monetary conditions.
Perhaps even more importantly, Yellen indicated during her press conference that rates might be expected to rise six months after the taper was done and quantitative easing ended.
That puts the first rate rise in the first several months of next year, a good bit sooner than markets had been anticipating.
"It depends what conditions are like" in the labour market, Yellen said, by way of hedging, also noting that the Fed might hold if inflation stayed low.
Still, the central forecast is for getting higher rates without getting much of a recovery.
That is terrible for financial markets, which duly sold off.
It is interesting, too, that Yellen argued we should be paying more attention to the FOMC statement, which was a record 877 words, than to the hard data in the charts and forecasts of the economic projections.
Words, as any lawyer will tell you, are inexact in their meaning, a state to which the FOMC statement always seems to aspire and usually reaches.
That desire, if that is what it is, for wiggle room, was also underscored by the decision to drop the 6.5 per cent unemployment rate threshold.
Two options seem possible to me:
- That the Fed is more hawkish, but does not really want to discuss it that openly.
- That giving the impression of rates going up more quickly was a bit of a communications fiasco.
If we look at the first, it is significant that Yellen said some Fed officials "note that the potential growth rate of the economy may be lower, at least for a time".
If the potential growth rate of the economy is lower, keeping low rates will not give you as much bang for your buck, but will still potentially distort markets and the economy. That is an argument for raising rates sooner, a sort of argument of exhaustion with low rates.
The Fed also seems to see normalisation of rates but sees that normal as being lower than before, another nod to lower potential growth. That is a sclerotic, stagnant economy, and a disaster for risk assets.
Now, on the other hand, as is so often the case, the Fed may look around at the falls in financial markets and rethink its position. Yellen may simply have made a rookie mistake in being so specific about the timetable and may wish for a do-over.
It is very possible that we see a row back, a bit more dovishness, in the next week or so from Fed officials.
If not, Santa Claus Fed - that old tendency for the market to usually rise around FOMC meetings - may be a thing of the past.