The airwaves have been filled with quite a bit of noise about the Fed and where they are with policy (aka, interest rate hikes). Both hawks and doves have been vocal, and I think it’s safe to say that every single committee member has been sharing their opinion – sometimes flip-flopping. But we should really be paying attention to only one person, Chair Janet Yellen. Everyone else is just adding to the noise.
She has the most influence on policy of any committee member, and she is quite persuasive in arguing her point of view. Her recent comments suggest that a pause in interest rate hikes is coming, and while she still expects some upward movement, she has made it clear that both she and the committee are paying close attention to economic growth prospects for the US.
The committee’s challenge is to not disrupt the economy or markets when entering a hawkish phase – easier said than done. The market’s sensitivity was in plain view following the December 2015 rate hike. Equity holders got scared, sold like crazy, and flocked to the one instrument you would think would be avoided – bonds.
Why did this happen? It appears that the traders and investors who bought bonds were convinced the Fed was going to raise rates and push the economy into a recession. When the long end of the curve drops as the short end rises (curve flattening), an inverted curve usually comes next – and that’s a recessionary sign.
At this point, the curve is unlikely to invert. Short term interest rates are near zero, and long term rates are near 1% (for 5 years) or higher. However, a flat curve will sow enough doubt in the economy that the Fed’s hand will be forced. They’ll have to put an easing program in place or keep rates low for longer. Ben Bernanke suggested three recent blog posts (you can find them here, here, and here) that the Fed has some more tools at its disposal. Economist Tim Duy, who aggregates the contents of the most recent Fed meeting minutes, concluded that the Fed is on hold for now until the data is compelling enough – same as it ever was!
To be sure, the Fed is miffed by the lack of inflation, but it may tolerate higher levels (or as Duy says “an overshoot.”) The markets may not be ready for it – but the Fed is signaling this could happen. Here’s why: The economic data is mixed to mostly sour, and the recent change to Atlanta Fed GDPNow suggests Q1 is coming in at around 0.4%. That’s not unusual for a Q1 number. We had low results in 2014 and 2015, but in both instances that was due to poor weather. Q2 bounced back smartly in those years – and I believe the Fed is counting on the same occurrence this year.
But then we have Atlanta Fed President Dennis Lockhart saying he thinks THREE rate hikes are likely this year. One wonders if he is actually reading the data, as many believe hiking rates into a weakening economy sends the wrong message.
Bottom line: the Fed is concerned about growth and low inflation, and interest rate hikes are on hold for now. But as Yellen pointed out last week, the employment picture has improved greatly. The Fed may have hit their mandate of maximum employment. Let’s hope the mandate of price stability is next.
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