The Fed continued its zero interest rate policy and provided few, if any, other than vague clues in either Chair Yellen’s press conference or in the statement itself about the exact timing for the first policy move and what the trajectory will look like. This is despite the fact that Chair Yellen has repeatedly emphasized that the timing of the first rate move is not nearly as important as the path. The only operational information we were left with was that the first move will likely occur sometime this year, but only if the data supports that decision. And the path will be gradual, whatever that means.
Are there any clues regarding either of these issues in the SEP projections that were released along with Wednesday’s statement? There are several noteworthy pieces of information in Wednesday’s SEP projections. First, there was a significant downward adjustment in the GDP forecast for 2015. The June central tendency now stands at 1.8% to 2%, as compared to the March estimate of 2.3% to 2.7%. This revision undoubtedly reflects the negative growth experienced in the first quarter of this year, though we did have a similar first quarter in 2014 as well. Second, at least 3 of the 15 participants estimated GDP growth between 1.7 and 1.8% for 2015. So with such low growth and ongoing questions about the labor market, it is hard to see a significant uptick in inflation sufficient to justify more than, at most, one rate hike in 2015.
This brings us to the problem with the emphasis that many observers place on the position of the median forecast and its movement from meeting to meeting. Here is where a clear understanding of the dot chart comes in. At present, 7 participants have the policy rate by the end of 2015 between zero and .5%, while 2 still have the policy rate unchanged at its present level of zero to .25%. It is fair to infer that there is a high probability, given their public speeches, that the likely candidates for the no-change position are Presidents Evans, Rosengren, and Kocherlakota. Of these, only President Evans is a voting member of the FOMC this year. The only governor who is likely, based upon public statements, to have the funds rate in the .5% to .75% range by the end of the year is Vice Chairman Fisher. This leaves the coalition of four governors, President Dudley, and President Evans as the group most likely to favor only one rate move, given the present forecasts for 2015. Since there are only 10 voting members of the FOMC at this time, the 6 voting members mentioned above who are inclined at this time toward one policy move constitute a majority and control the vote. Furthermore, there are others who vote who have never failed to vote with the majority. For this reason, it is important not to focus on the central tendency of the policy rate projection but rather to consider who votes and what their inclinations are.
As for the meaning of “gradual” as it applies to the likely path for policy, looking at the 2016 dot chart, we see 4 participants with the policy rate between 1.25% and 1.5% by the end of that year. Three more foresee the policy rate as less than that. If the FOMC were to move the range for the policy rate in 50-basis-point increments, logic suggests that such a move would likely come every other meeting. Should the economy’s strength surprise the Committee, then the rate would be higher. But the question then is whether this path would meet the definition of “gradual.”
Finally, some have noted that the FOMC seems to be anticipating at least one policy move this year, with more moves next year. Yet markets have not fully priced those moves into the term structure. Why not? One needs to keep in mind that the SEP forecasts are constructed to reflect what the FOMC believes the path of policy “should” be whereas markets are reflecting the belief as to what the path of policy “will” be. This suggests the divergence in the two paths could be interpreted as an index of the effectiveness and credibility of Fed communications and forward guidance.
While torturing ourselves with this kind of parsing of the SEP forecasts and Committee speeches isn’t desirable, it is necessary because of the failure of the Committee to deliver on a more meaningful communications policy, one that affords us more substantive guidance than “policy is data-dependent.”
Bob Eisenbeis, Vice Chairman & Chief Monetary Economist.