Federal Reserve Chair Janet Yellen shows signs of taking a page out of her predecessor’s policy playbook as she inches toward the central bank’s first interest rate increase in nine years: Delay action in September only to move in December.
While the Fed on Thursday opted to keep rates pinned near zero for now, Yellen told a press conference that most policy makers still expect to raise rates this year. She highlighted the strength of the US economy, tying the decision to delay liftoff to fresh uncertainty about the outlook abroad and to financial market turbulence over the past month.
“I do not want to overplay the implications of these recent developments, which have not fundamentally altered our outlook,” she said. “The economy has been performing well, and we expect it to continue to do so.”
Yellen’s approach has parallels to the strategy that former Fed Chairman Ben S. Bernanke pursued in 2013 as officials debated whether to start scaling back bond purchases. Citing uncertainties to the outlook, Bernanke put off a move to begin tapering in September before deciding to go ahead in December.
Just like today, much of the Fed’s initial reservations about acting in 2013 centered on developments in emerging markets, which had been rocked by Bernanke’s suggestion a few months earlier that a taper was on its way. Looming in the background then, as it is now, was the threat of a US government shutdown.
Then and Now
Today’s situation “lines up in so many ways” with that of 2013, said Aneta Markowska, chief US economist at Societe Generale in New York, pointing to the upcoming fiscal showdown and emerging market concerns. “If all of that is resolved by December, my expectation is that the data will definitely support a hike.”
Investors may get more clues to Yellen’s thinking when she speaks on Sept. 24 in Amherst, Massachusetts.
Traders in the federal funds futures market marked down the chances of a December rate rise to below 50 % following news of the decision, compared with 64 % on Wednesday. That’s based on the assumption that the effective fed funds rate will average 0.375 % after liftoff.
“When they didn’t go then, I think there was a very strong sense that they would go in December,” said Michael Feroli, chief US economist at JPMorgan Chase & Co. in New York, referring to Bernanke’s taper. “Now, people are even having doubts about whether they will even go this year.” Feroli himself forecasts a December move.
Yellen said the Federal Open Market Committee discussed the possibility of raising rates at this week’s meeting, but decided not to in light of the heightened uncertainties abroad and the slightly lower expected path for inflation.
Wait and See
“The Committee judged it appropriate to wait for more evidence, including some further improvement in the labor market, to bolster its confidence that inflation will rise to 2 % in the medium term,” she said.
Slowing growth in China has rippled across the world, hitting commodity-producing countries hard. Domestically, Fed officials are also grappling with an inflation rate that remains too low, rising just 0.3 % for the 12 months ended July, according to the Fed’s preferred measure of price pressures.
“They clearly are a bit risk averse,” said Luke Tilley, chief economist at Wilmington Trust in Wilmington, Delaware, which manages $77 billion. “They are ultimately looking for that confidence for inflation to come back up.”
Tilley said Fed officials will be watching for some stabilization in commodity prices and a firming in market-based measures of inflation expectations.
Yellen said the FOMC “has taken note” of recent declines in those measures and would “continue to monitor inflation developments carefully.”
“I think our credibility hinges on defending our inflation target, not only from threats that it rises above, but also that we not have, over the medium-term, that we want to see inflation get back to 2 %,” she said.
She also repeatedly highlighted the importance of continued improvements in the jobs market to help buttress her confidence that inflation ultimately will rise back to the Fed’s 2 % goal. In Yellen’s view of the world, wage increases — and inflation — should start to accelerate as unemployment falls further and further.
The economy created 2.92 million jobs in the year ended in August, pushing the jobless rate down to 5.1 %, around the level that many Fed policy makers consider full employment.
The labor market isn’t the only thing percolating. Consumer spending, which Yellen said was the main driver of the economy, climbed 3.2 % in the 12 months through July, among the best year-over-year readings of the current expansion. And the turmoil in financial markets didn’t deter households in August, with auto sales climbing to their highest level since 2005.
“We are looking at, as I emphasized, a US economy that has been performing well and impressing us by the pace at which it is creating jobs and the strength of domestic demand,” Yellen said.
While she held out the possibility of the Fed raising rates at its next meeting in October, economists and traders weren’t buying it. The odds of a move next month are only about one in five, according to dealings in the fed funds futures market.
Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York, said it may even be tough for Yellen to fully convince investors that the Fed is going to go ahead with a rate rise this year.
“It is going to be very hard to change market psychology,” he said. “Traders feel the odds favor additional delay on Yellen’s part.”
“My forecast is December, but I would not stake my life on it,” he added.
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