Nearly as important as monetary policy, is policy communication, and the Fed’s messaging is not getting any easier to interpret.
The Fed’s official message, since the Federal Open Market Committee (FOMC) raised the Federal funds rate on Dec. 16, is that further rate hikes will be “gradual.” But the definition of gradual keeps evolving. Further clouding central bank communication is officials’ divergent, ever-shifting rhetoric.
Market players, much less the public, can be excused for being a tad unclear about Fed intentions. At liftoff, FOMC participants projected, in their dot plot, an average of four additional rate hikes in 2016, taking the funds rate to 1.375% by the end of 2016. For the end of 2017 the median funds rate projection was 2.4%, implying four moves. But when Fed Governors and Presidents revised their economic forecasts by March 16, the number of projected funds rate hikes was cut in half over the next two years, leaving it at 0.9% at the end of 2016 and 1.9% at the end of 2017.
Suddenly, gradualism got a lot more gradual, leaving Fed rate expectations more in line with the market.
The FOMC’s decision to stay on hold in March was not terribly surprising. In January, the FOMC said it was “closely monitoring global economic and financial developments,” in assessing their implications for the labor market and inflation. New York Federal Reserve Bank President William Dudley told me not long after, that deteriorating financial conditions had intensified Fed fears about global economic headwinds.
“Obviously, one thing that shapes your outlook is: Are financial markets doing what they’re doing in response to actual developments in the global economy?” Dudley asked. “If you think they are, then you’re going to tend to assume that those moves are going to be more persistent. So you take them more seriously.”
By March 16, markets had stabilized somewhat amidst better economic data, but many of the same fears lingered. As the FOMC said then, “global economic and financial developments continue to pose risks.”
Explaining the seeming disparity between stark declines in the dots and modest forecast changes, Yellen told reporters, “Most committee participants now expect that achieving economic outcomes similar to those anticipated in December will likely require a somewhat lower path for policy interest rates.”
Why? Elaborating, Yellen said the downshift in rate projections, “largely reflects a somewhat slower projected path for global growth and for some tightening in credit conditions in the form of an increase in spreads.”
Not long after the FOMC stayed on hold and reasserted its gradual approach, conflicting signals began to rattle markets. “All else equal, then April or June would definitely be potential times to have an increase in interest rates,” San Francisco Fed President John Williams, Yellen’s former top advisor, said two days after the FOMC and pledged to go slow.
Atlanta Fed President Dennis Lockhart says, “There is sufficient momentum evidenced by the economic data to justify a further step at one of the coming meetings, possibly as early as April.”
Even Boston Fed President Eric Rosengren, not thought of as a hawk, questioned the “extremely gradual” rate path implied in Fed fund futures pricing and warned, “If the incoming data continue to show a moderate recovery—as I expect—it will likely be appropriate to resume the path of gradual tightening sooner than is implied by financial-market futures.”
When Yellen sallied forth in late March to assert the Fed would “proceed cautiously,” she was widely seen as pushing back against her colleagues’ hints of early rate hikes. But her comments were not significantly more dovish than in her post-FOMC press conference.
While Yellen may have been trying to counter the flurry of April rate hike comments, her message may have been that rate hikes are likely to be neither as many as the FOMC projected in December or as few as the market expects. The FOMC has repeatedly said policy will be data dependent and not preset. Clearly global economic and financial developments will also figure to the extent they are seen altering the domestic outlook. Fed policymakers are keen to avoid being perceived as not being dictated to by the market, but the fact is market trends matter a great deal.
One gets the sense that, as Yellen & Co. feel their way along, they will take what the market gives them and what the economy seems to allow and no more. The 2013 “taper tantrum” is fresh in officials’ minds.
With inflation expectations slipping and global uncertainties still rife, most policymakers see no need to aggressively tighten policy. They are not about to get very far out ahead of markets.