In the wake of Chair Yellen’s speech in New York on Tuesday, economic commentators and pundits have already begun speculating on the prospects for a second rate hike at the FOMC’s April meeting. My assessment is that, given the current flow of economic data and the discussion by Chair Yellen, the probability of a policy move in April is low, if not close to zero. This is notwithstanding her assertion that each meeting is a live meeting when it comes to consideration of policy moves. Several reasons point to this conclusion.
First, in her speech Chair Yellen discussed the Committee’s assessment of the economy, which she then supplemented with her own views. She made it abundantly clear that the Committee “expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.” Part of the rationale for this assertion is that, since the last policy move in December, significant developments have warranted a more cautious approach. These include the continued movements in oil prices, the introduction and expansion of negative interest rates by major central banks, the slow pace of investment, lackluster business sentiment, the appreciation of the dollar, the slow pace of household formation, and Committee concerns about spillover to the US economy from slow growth abroad. All of these factors have heightened the downside risks to the Committee’s overall growth forecast, even though the basic trajectory hasn’t been significantly reduced. Management of downside risks is a key concern of the FOMC at this point, and the perceived risks have increased more since the last meeting, when the decision was made not to change rates again.
Second, the inference from the analysis Chair Yellen offered is that the increase in downside risks would have been greater were it not for changes in market expectations that have put downward pressure on longer-term interest rates that tends to provide additional support for continued spending by consumers and, hopefully, businesses as well. Thus, market reactions actually acted as a substitute for easing by the Fed. This easing tended to support the basic trajectory for the economy in the Committee’s forecasts and tended to mitigate what might otherwise have been a reduction in that trajectory.
Third, Yellen expressed some concern about the inflation outlook and the speed at which it will return to the Committee’s 2% objective. She argued that PCE inflation will remain well below 2% throughout 2016 and then move only gradually up through 2017 and 2018. Clearly, if foreign growth slows and oil prices once again decline, these factors will slow the evolution of inflation towards the Committee’s objective. But at the same time, such a development is critically dependent upon the stability of expectations for future inflation. Here, too, Chair Yellen notes her concerns that inflation expectations may actually be drifting down, based on both market-based measures and reported expectations in the Michigan Survey. For these reasons, the FOMC can reasonably conclude there is no need to rush to make another rate move.
Fourth, given all these concerns, uncertainty has increased regarding when the economy might attain the Committee’s objectives and how that timing might affect the future rate moves. As we have argued in previous commentaries, key data on first-quarter real GDP will not be available until June, so the Committee will have only one additional observation on employment and inflation by the upcoming April meeting; and recent data on corporate profits, consumer spending, and housing and durable goods, including goods for business investment, are not consistent with an economy that is growing rapidly or at risk of overheating. These data are simply not consistent with an April policy move.
Finally, if there is little or no chance of a policy move in April, why the insistence that each meeting is a live meeting? The reasoning here seems obvious. Policy moves should be decided at official meetings, not through informal consensus in advance of, or instead of, an actual meeting. Preserving optionality, even if there is little or no probability of a rate move, is critical to the integrity of the decision-making process. Otherwise, there would be no need to meet if an actual policy move was not on the table. But the preservation of optionality also means that markets do not need to take literally the assertion that each meeting is live.