Category Archives: Federal Reserve Policy

September 19-20 2017 FOMC Meeting

In a Nutshell: “In October, the Committee will initiate the balance sheet normalization program.”

Decision: Fed funds rate maintained at 1.00% to 1.25%: Balance sheet normalization begun.

The great experiment of quantitative easing is over. The Fed calls the act of reducing its ownership of assets “balance sheet normalization” and it is to begin in October. This is important and we need to view the normalization of both the funds rate and the balance sheet as a dual process. The Fed considers quantitative easing to be a tool that ranks only just behind interest rate (fed funds rate) management.

The process of raising the funds rate to its normal level, which today’s report indicates to be roughly 2.75%, started in December 2015. Eleven of the sixteen members expect another hike in December and at least three more next year. The funds rate normalization process is proceeding at a reasonable rate and should continue to do so, barring a major economic problem.

The second tool, quantitative easing/tightening, had yet to begin before this meeting. Before the financial crisis, the Fed’s balance sheet was below $1 trillion. Now, it is about $4.5 trillion. When interest rates approached zero, the Fed turned to asset purchases to increase liquidity in the system and keep the whole range of interest rates low. This was supposed to add to growth.

The consensus is that the Fed needs to shed somewhere in the range of $2 trillion to get to a “normal” balance sheet. The process, as outlined in June, is for this reduction to begin slowly so the Fed will start rolling off only $10 billion per month starting in October. That will slowly ratchet up to at maximum of $50 billion per month by the end of next year. But the process has a long way to go and it needed to get under way. Balance sheet reduction is expected to continue unabated, barring an economic crisis.

So, why is the Fed normalizing the levels of its tools? Inflation is still below its target and while the economy is near full employment, there may be room to for the rate to decline further. The answer is simple. The Fed’s quiver is largely empty. If the economy falters, does anyone believe The Fed can really add another few trillion dollars to its balance sheet? As for the funds rate, would a reduction of only one percentage point provide much policy impact?

The Fed needs to positions itself so it can provide all the stimulus needed if the economy falters. That is their thinking now and it is why they have begun to reduce their balance sheet and raise rates. The members will move as quickly as reasonable, though the process could take over two years for the funds rate and as much as five or six years for the balance sheet.

(The next FOMC meeting is October 31-November 1, 2017.)

Fed Chair Janet Yellen’s Speech at the Jackson Hole Conference

IN A NUTSHELL: “Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.

All week, we have waited for the talk that Fed Chair Janet Yellen would give at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming. This has become “THE” monetary policy meeting as Fed chairs have, in the past, sometimes signaled changes in policy. If you were hoping that would happen this year, forgetaboutit.

Yes, the Fed Chair did note that economic conditions have improved recently, which is a surprise to only those who have been stuck on Mars with Matt Damon. And yes, there is now a decidedly more hawkish (i.e., rate hike biased) view of monetary policy coming out the Fed. But that has happened before when conditions had improved. However, the sudden appearance of any issue of any kind sidetracked the Fed.

Indeed, Chair Yellen did note: “Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee’s outlook.” So, if we get a softer than expected jobs report or weaker consumption numbers or whatever before the September 20-21 FOMC meeting, the Committee could or will likely do nothing.

The bulk of the comments centered on monetary policy tools. While it was an interesting discussion, it could only be appreciated by monetary policy geeks.

So, what did we learn? There is a possibility that the Fed could raise rates in September, but only if the data are “confirm the Fed’s outlook”, whatever that is today or next month. The only way I see a rate hike next month – and I have been a major proponent of the Fed raising rates for the past eighteen months – is if the economic data are so strong the Fed has no choice. I hope that actually turns out to be the case, as it would indicate the economy is accelerating, the labor market is strong and wages and spending are rising solidly. If you are holding your breath, keep an oxygen tank near by.

July 26-27 2016 FOMC Meeting

In a Nutshell: “Near-term risks to the economic outlook have diminished.”

Rate Decision: Fed funds rate range maintained at 0.25% to 0.50%

Well, the “data driven” Federal Open Market Committee met again and was driven by the data. Since the numbers were better between the June meeting and today, the Committee determined that the economy was getting better – again. Not a surprise. One thing this group has been consistent about is its one meeting the sky is falling, the next meeting the sun is coming out approach to economic analysis. This was the good economy meeting that comes after the worrisome economy meeting.

As for the economy, the members were actually fairly positive about things. Here is what they said: “Information received since the Federal Open Market Committee met in June indicates the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months. Household spending has been growing strongly but business fixed investment has been soft.” This contrasts with the largely worrisome description of the economy in the June 14-15 meeting. As for Brexit or other international fears that have prevented rate hikes over the past year, the members seem to have said “never mind” and dropped those issues into the factors they are monitoring – which are just about anything that could cause a problem that would provide an excuse to do nothing.

So, what will the Fed do this year? This statement was positive on the economy and pessimistic about, well nothing. By saying that the “near-term risks to the economic outlook have diminished”, the members have opened the door, once again, to a rate hike. There are two more employment reports between now and the September meeting. We get second quarter GDP this week but that was last quarter and the members will need to see solid third quarter growth as well. And, of course, some country could come down with an ingrown toenail that would terrify the Fed. So, while it is likely the economy will be strong enough for the Fed to raise rates in September, it is hard, right now, to predict that.

Today’s statement seems to indicate we should get at least one increase this year. If that doesn’t come in September, then the December meeting is likely since the November meeting is one week before the election. How a rate hike would help or hurt either candidate is beyond my comprehension (if you can figure it out, please tell me), but this Fed takes no chances on anything.

(The next FOMC meeting is September 20-21, 2016.)

December 15-16 ‘15 FOMC Meeting

In a Nutshell: “That’s one small step for the Fed, one giant move toward normal financial markets.”

Rate Decision: Fed funds rate range increased to between 0.25% and 0.50%

Well, they finally did it. After hinting and backing off, The FOMC raised the fed funds target range by one-quarter percent. This is the first move of any type since December 16, 2008, when the 0% lower bound was hit, and the first increase since June 26, 2006, when the 25 basis point increase brought the rate to 5.25%. In between we had the housing bubble bursting, the financial system in near collapse and a recovery that is still scarred by the excesses of the last decade.

Very simply, it is good to get this finally out of the way. History will determine whether this was the right time to make a move, but it had to be made and in my mind, this was as good a time as any. Actually, I think if they had gone in June or September, that would have been fine as well, but I don’t want to be critical – at least not right now.

Most importantly, we can now focus on the next stage of the move back to normal bond and stock markets. There are lots of additional actions that must to be taken: We need a funds rate that reflects normal conditions, the Fed’s balance sheet needs to be shrunk and assets need to be shed, and the markets’ obsession with Fed future actions, or lack thereof, must be reduced.

So, where do we go from here? There is little doubt that “the data” will drive Fed decisions – they just keep telling us that. So let’s project out one year from now. The unemployment rate is likely to be at or even below 4.5% and labor shortages will be common, wages will probably be rising at a solid pace, the restraining impacts of declining energy costs should be behind us and businesses will be needing to make up for lost ground due to all the uncertainties they have faced. In addition, Europe will have another year of quantitative easing and China will be another year into its transition to a more balanced, consumer-driven economy. In other words, the economic environment is setting up for a very solid 2016 that should support moves at roughly every other meeting to begin with but maybe more frequently by the end of next year.

But reading the Fed’s statement, while the members seem to be comfortable with current and future economic conditions, there appears to be some unease about the inflation prospects. The Committee mentioned that some surveys indicate that inflation expectations have “edged down” and there was an added statement that inflation would be monitored closely. Since inflation is still an outlier, the pace of future hikes may be linked more to progress on reaching the Fed’s 2% inflation target than on the strength of economic growth. The problem, of course, is that inflation tends to be a lagging indicator. As economists used to note, “If the Fed waits until it sees the whites of inflation’s eyes, it has waited too long”.   It is not clear what the Fed will use as a leading indicator of inflation.

Looking longer-term, since the Fed has to get to a “neutral” funds rate before inflation heats up, and that rate is assumed to be about 3.5%, the FOMC has a lot of work to do. Unless the economy slows, energy prices keep falling and the dollar keeps rising, it is doubtful it will take three years to get there.

Finally, unless we have a perfect economy and inflation stabilizes close to the Fed’s 2% target, the FOMC will not stop at neutral. It hasn’t in the past and there is little reason to believe it will now. So when you start thinking about the terminal rate, it is prudent to assume that it is above the 3.4% long-term rate the members indicated in their “dot chart”. Don’t be surprised if we get to 4.00%. But for the next nine to twelve months, expect only gradual increases in rates.

(The next FOMC meeting is January 26-27, 2016.)

FOMC Commentary, November Leading Indicators, December Philadelphia Fed Survey, Jobless Claims

KEY DATA: Leading Indicators: +0.6%/Philadelphia Fed: 24.5 (-16.3 points)/Jobless Claims: 289,000 (down 6,000)

IN A NUTSHELL:   “The Fed may be shifting into “patience” mode, but the economy is continuing to accelerate.”

WHAT THE DATA MEAN: Today’s economic reports showed that the economy continues to improve.  The Conference Board’s Leading Economic Index jumped again in November and it looks like the increases are pointing to a very strong economy going forward.  Looking at a graph of the index, the rise seems to match the 2003-2004 housing bubble economic surge.  Supporting the view that the economy is picking up steam was another fall in weekly jobless claims.  The jump in claims near Thanksgiving seems to have been a one-week wonder and we are back to record lows, when adjusting for the size of the labor force.   As for the Philadelphia Fed’s Business Outlook Survey, a large decline was expected.  This index can be very volatile and the November number was one of the highest on record.  The December level also points to strong growth, especially since orders remain solid. 

FOMC Commentary: Yesterday, the Fed did and didn’t do what I thought they would and should do: Remove the “considerable time” phrase.  Maybe.  It didn’t do it because it repeated it.  But more importantly, the Committee substituted a new comment,that it can be patient (emphasis added) in beginning to normalize the stance of monetary policy”, and noted that patience and considerable time were similar if not equal.  Getting confused?  No kidding!  The statement seems to be the most tortured attempt at changing the psychology surrounding the timing of tightening I have seen.  I guess that is what happens when you worry more about market reaction than policy clarity.  We know little more now than we did before the meeting and press conference.  So much for better communications.

So, what does patience mean, when it comes to rate hikes?  Chair Yellen said we have a breather for the next two meetings. However, the chart of fed funds rate expectations points to a tightening in 2015, which will likely come at around mid-year.  What would make her lose her patience?  Stronger growth and that is where the data come in.  By the time we get to the April meeting, we will have three more employment reports and GDP numbers for the fourth quarter of 2014 and first quarter 2015.  If the Leading Indicators are pointing to anything it is the string of 3.5% growth rates could be sustained.  If that is the case and the job gains are above 250,000 and the unemployment rate continues to decline, it would be hard to see how wage increases don’t accelerate.  But I am guessing that patience will be tied to compensation and until we actually see large increases in wages, the Fed will continue to dawdle. 

October 28-29 ‘14 FOMC Meeting

In a Nutshell: “…the Committee decided to conclude its asset purchase program this month.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

Quantitative Easing Decision: Ended.

The FOMC met and issued its statement about economy and the direction of monetary policy.  Not surprisingly, the Committee decided to end, finally, quantitative easing.  The members also reiterated “that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program.”

While the ending of QE3 and the continued use of “considerable time” were expected, there were enough changes in the statement to make it clear that the Fed is transitioning to rate hikes.  First, and maybe most importantly, the members now believe “a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing” rather than “there remains significant underutilization of labor resources.”  Since it is all about the labor market, it is now clear that the Fed believes the labor market is tightening.

But it wasn’t just the comments about the labor market that make this an important statement.  The Fed also signaled it is less concerned about deflation.  The Committee noted that “the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year”.  This is in contrast to just saying it was running below its desired pace.

So, what is the take away from the Fed’s comments?  If we keep seeing the kind of economic progress that we have had for the past few months over the next few months, the Fed will have to start talking specifically about tightening.  Between now and the December 16-17 FOMC meeting, we get third quarter GDP and two more employment, consumer spending and inflation reports.  Don’t be surprised if at that meeting, there has been enough strong data that the Committee removes the “considerable time” verbiage as a signal that the time for rate hikes is coming sooner rather than later.  I am sticking with my expectation that the first increase will come in the spring, possibly as early as the March 17,18 meeting.

How should the markets take this statement?  First, there really should not have been any surprise in it.  If people didn’t know QE was over, they probably made the mistake of flying into New Jersey and wound up being quarantined.  On the labor market front, I have been arguing for months that things are better than the common wisdom and the Fed’s edging toward that view also should not have been shocking.  But uncertainty on the timing of rate hikes remains, though those who pushed things off until well into the second half of next year are probably backpedaling, again.  Thus, we are still in for lots of volatility when the economic data surprise either on the upside or downside.  Rates are going up next year, so let me remind everyone that eight meeting times 25 basis points per meeting comes to 200 basis points in a year.

Sept 16-17 ‘04 FOMC Meeting

In a Nutshell: “… a range of labor market indicators suggests that there remains significant underutilization of labor resources.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

Quantitative Easing Decision: Bond purchases reduced by $10 billion to $15 billion.  Quantitative easing is expected to end at the next meeting.

One again, the FOMC and Janet Yellen tried to provide some clarity about how the monetary authorities will proceed with rate hikes when they eventually come.  And again, we did not get much that was new.

On the economic front, the economy continues to improve but there remains a significant amount of slack in the labor market.  That was Chair Yellen’s reason why wages are showing little change.  It is all about a tight labor market and the Fed doesn’t see that situation occurring soon.  As it does four times a year, the FOMC released the members’ forecasts for growth, inflation and unemployment rates. The central tendency of the forecasts puts full employment in the 5.2% to 5.5% range, which is not expected to be reached until sometime in late 2015 or early 2016.  However, the members are a bit more optimistic about pace of decline in the unemployment rate.

As for when the Fed might tighten, those who thought that the FOMC might signal that rates could rise sooner rather than later were disappointed.  The Fed Chair made it clear that she was in no hurry to raise rates.  But she also noted that the decision is not “calendar driven” but is “data driven”.  The hawks are not making very much inroads into Fed policy.

Finally, the Committee went over procedures for normalizing policy.  One new thing was that the FOMC would be targeting rate ranges rather than a given rate.  That may be reflection of the concern that transitioning to a normal Fed policy and a normal Fed balance sheet will likely have some bumps in the process.  It would be amazing if the Fed pulls off the normalization process without any hiccups.

So what should we make of all this?  Janet Yellen is firmly in command at the Fed and we should stop doubting it.  She is a dove and until the data make her think differently, she will run monetary policy accordingly.

But I have some issues with the Fed’s forecast.  The unemployment rate has declined by about 0.7 percentage point for the past three years yet the members think the decline will slow sharply starting in 2015 and only edge down in 2016 and 2017.  Yet growth is expected to be a lot stronger over the next two years than it had been.  This doesn’t seem to be consistent.  But it is necessary for the members to argue that the funds rate will not be increased soon and will not be raised quickly, which they seem to be indicating.

August Conference Board Online Help Wanted

KEY DATA: Ads: up 164,600

IN A NUTSHELL:  “With job openings rising as unemployment is falling, is there really any doubt that the labor market is tightening?”

WHAT IT MEANS: Businesses are out there looking for workers all over the place.  The Conference Board’s Help Wanted Online Index jumped sharply in August.  The rise in labor demand was spread across the nation as only five states had lower levels of ads.  Seventeen of the top twenty metropolitan areas reported gains.  Philadelphia was not one of them, though.  Which jobs are seeing an increase in demand?  All of them!  Every occupation category posted a rise in want ads.  All of this is created some real labor shortages, not just a tightening in the labor market.  The ratio of the number unemployed to the number of job openings is a measure of labor availability.  Over the past three months, that ratio has averaged 1.93 workers per opening.  To put that in perspective, from May 2005, when the data were first released, to December 2007, when the expansion ended, the ratio averaged 1.95.  In other words, the current measure of availability is lower than what it generally was during a significant portion of the previous expansion.  Looking at occupations, computer and mathematical science, healthcare practitioners, management and business and financial operations all have ratios less than one.  In other words, they have already hit labor shortage status.

MARKETS AND FED POLICY IMPLICATIONS:  We still have to wait for Friday’s report to see how much, if any, the labor market tightened in August.  Regardless, most of the labor market tightness indicators are flashing red.  So, why are we not yet seeing any pressure on wages?  My argument, which I have made a number of times in the past, is simple:  Business leaders have not had to worry about compensation or attraction and retention issues for so long that they don’t believe they have to do anything but pick the perfect job candidate and pay the person what they want to pay them.  Well, Bob Dylan said it best: “The times, they are a-changin’”.  Maybe the best way to end this piece is to quote the lyrics, which when it comes to the labor market may be the clearest warning:

Come gather ’round people
Wherever you roam
And admit that the waters
Around you have grown
And accept it that soon
You’ll be drenched to the bone
If your time to you
Is worth savin’
Then you better start swimmin’
Or you’ll sink like a stone
For the times they are a-changin’.

(Copyright © 1963, 1964 by Warner Bros. Inc.; renewed 1991, 1992 by Special Rider Music)

Fed Chair Yellen Talk at Jackson Hole Conference

In a Nutshell: “… if progress in the labor market continues to be more rapid than anticipated by the Committee, then increases in the federal funds rate target could come sooner than the Committee currently expects … Of course, if economic performance turns out to be disappointing … then the future path of interest rates likely would be more accommodative than we currently anticipate.”

If you don’t like two armed economists, you will truly dislike the talk that Fed Chair Janet Yellen gave today at the Federal Reserve Bank of Kansas City’s Economic Symposium in Jackson Hole, Wyoming.

The greatly anticipated speech delved into the details of the labor markets, the impact of wages on inflation and the way that monetary policy should react.  Of course, being a good economist and academic, Chair Yellen discussed all sides of the issues.  For example, is the decline in the participation a result of changing structural factors such as the aging workforce or is a cyclical decline due to frustration that will unwind once the labor market firms more?  The answer is, of course, yes.  That is, it could be one, or the other or even both, which it likely is.

Similarly, there were discussions about wage pressures, how long it could take for wages to rise faster and when rising labor costs would actually translate into rising inflation.  As any economist will tell, the answer is hardly clear since there are multiple competing factors.  Thus, wage pressures could ignite quickly or be delayed.  Rising wages could signal future increases in inflation, or maybe not.  The Fed should react quickly to rising wages or maybe wait if the wage increases are temporary.  In other words, the answer is any or all of the above.

So, given the talk, is there anything to take away from the speech?  Yes.  First, the Fed members recognize that we are a lot closer to their desired goals than they had projected.  Second, the lack of wage inflation is not necessarily a good sign for future inflation.  The apparent current slack in the labor market could disappear more quickly than expected.  In the past, the Fed Chair had generally been on the side that current labor market conditions argue for keeping rates low for an extended period.  Now, those same conditions need to be watched more carefully.

If Janet Yellen was viewed believing the labor market had plenty of slack and wage pressures would not build anytime soon, that perception has to change.  She recognizes that the risks are more balanced.  That means she will be more willing to move rapidly if the economy continues to improve surprisingly quickly.  Thus, investors should not assume any time frame for Fed rate hikes.  It is easy for economists and market analysts outside the Fed to pick a date.  But today’s talk makes it clear that if the Fed has to move sooner or deems it necessary to wait longer, the Fed Chair is totally prepared to go in that direction, whatever it may be.

July 29, 30 ’14 FOMC Meeting

In a Nutshell: “…a range of labor market indicators suggests that there remains significant underutilization of labor resources.”

Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%

Quantitative Easing Decision: Bond purchases reduced by $10 billion to $25 billion

The latest FOMC two-day meeting was not expected to create any major change in the messages that the Fed members have been trying to send, and it didn’t.  But there were still some interesting takeaways from the statement.

If it is all about the labor market and wage pressures, then the Committee did elevate its thinking about the potential for rising compensation to the top of the discussion.  That said, the members then decided to downgrade the threat by indicating there was “significant underutilization of labor resources”.  There is still belief that the labor market will improve, but right now they seem to be saying potential wage pressures are not a threat.  The statement seemed to be a little more cautious about inflation, which has accelerated recently.  The comment was that “Inflation has moved somewhat closer to the Committee’s longer-run objective” rather than just being below target. I am not exactly sure how much worry that shows given the lack of concern about wages, but at least there was recognition that the rate is moving upward.

Otherwise, everything was expected.  The Committee knew that growth had rebounded in the spring and said so.  With growth back on track, it was easy to continue the reduction in asset purchases by another $10 billion.  It is likely that quantitative easing will be a thing of the past as of the October meeting.  But other than indicating that all funds would be reinvested, there was no indication of what will happen to the Fed’s balance sheet after asset purchases end.  As for the funds rate, it was repeated that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends”.  Since considerable time is about six months – per Janet Yellen – and the program should end in October, that gets us to April.  I think the March meeting is still a good possibility.

Okay, what does this all mean?  There seems to be a growing discontinuity between the firming labor market data, excluding wages, the upward trend in consumer costs and the Fed’s lack of concern about future inflation.  Indeed, it is unclear why the Fed believes that wages will not start rising faster by year’s end.  Keep in mind, the Fed has been so easy for so long that it will take at least two years or longer to unwind everything.  If they are using wages, which is a lagging indicator of a lagging indicator, to signal inflation pressures, then they are taking a fascinating gamble.  While I am not an inflation hawk by any means, it is time for the Fed to explain how it will know when labor market conditions are becoming tight.  My view is simple: If you wait until you see that wage pressures are building, it will be very late in the process to begin dealing with the rising cost pressures.  That is true for both businesses and the Fed.