Like one of those old Op-Art posters beloved of hippies, staring too long into the Fed’s dot chart of interest rate expectations can make you see things which aren’t there.
The Fed’s monetary policy statement on Wednesday has to be read as dovish, retaining as it does the “considerable time” language which some have taken for shorthand that interest rate rises are at least six months away (a characterization Janet Yellen disputes, at great length, but without enlightening us with much specificity). The statement also included other dovish touches, notably an acknowledgement that there “remains significant underutilization of labor resources” as well as new language noting inflation has been “running below” the Fed’s objective.
And yet, the so-called dot-chart, a scatter chart of where individual committee members expect rates will be in the future, has thrown a scare into some investors who feared that rate rises may be on tap sooner than expected.
Given the way the Fed schedule falls next year, “considerable time” might imply we won’t see rates rising until June. That is hard to reconcile with the dot chart, which shows rates, on average, at 1.27% by the end of 2015, up from a 1.20% average on the last dot chart in June. Given that the fed funds rate is now in a 0–0.25% range, it is going to be pretty busy trying to raise rates smoothly, a quarter percentage point at a time, if they start in June.
Hard too to square this with slower growth and generally mixed expectations for 2015 contained in Fed forecasts.
But as usual the dot chart rate rises are backloaded, with the average forecast for 2017, a new release, at 3.54%. There is, as so often, something slightly dubious about promising normalization, but not quite yet. After all, inflation last month actually fell and has been on a downward trend for some time. At the same time, while job creation has been OK, it has been inconsistent.
The dot chart may simply reflect divisions within the FOMC, reflected at this meeting by a second dissenting vote.
Nothing here gives the appearance of an economy ready for liftoff and normalization, and so we’d be wrong to expect it. Remember too that the markets have been running below where the dot charts imply that rate rises will be. Expect that to continue.
Low expectations
The Fed’s central problem is that it holds two potentially irreconcilable desires at the same time: a return to ‘normal’ monetary policy, preferably before the next recession, and inflation near 2% combined with a moderately strong labor market.
More specifically, the Fed needs to set the market up, convincingly, for a rate rise it may never be able to effect, or at least not for “a considerable time”.
Consider the costs to the Fed of the current policy – not very high in current terms. If anything the US can withstand a strong currency right now, and though low rates may be storing up bubbles these are future costs which are being weighted against pain suffered now.
Borrowing costs are low, though slightly higher than recently. Rather than worrying about the Fed, the ongoing rally in financial instruments along with low inflation has left many investors with a touching faith in the Fed’s ability to deliver, if not general prosperity and 2% inflation, then at least fat portfolios.
Much of this may boil down to the fact that, as forward guidance, the considerable time language is highly conditional. Should the Fed start to see rising inflation and a popping job market, that considerable period will pass in no time at all. The central bank won’t refrain from raising rates, or, as is more likely, keeping them low, if that is what is needed to try to meet its dual employment and inflation mandate.
That argues for paying close attention to economic forecasts, which are less optimistic about next year, and discounting rate forecasts.
Right now inflation is too low and employment too weak. The latter is getting better slowly, but inflation is stubbornly subdued. Unless you see reason that those conditions will change, best not to bank on rate rises on the scale of those indicated by the dots chart.
(James Saft is a Reuters columnist. The opinions expressed are his own. At the time of publication he did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com)
