FOMC Statement and Press Conference

March 18, 2015

Within the two hours after today’s FOMC statement was released and 30 minutes from the end of Janet Yellen’s press conference, the Dow Jones Industrial Average advanced 1.8%, the dollar fell by 1.8% against the euro and 0.6% versus the yen, and the 10-year Treasury yield swung from five basis points above the 2.00% threshold to seven basis points below.  Gold recovered 5.3%. 

The main message continues to be that Fed actions from here will be driven by the evolution of macroeconomic information and market-determined prices.  The word “patient” was dropped from the statement after just two usages in the previous communiques of December 17 and January 28, but the new text explicitly admonished that “This change in the forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”  Yellen added later that not promising to be “patient” isn’t a pledge to be impatient.  In Fed-speak where every adjective has special meaning, the word “patient” implied little likelihood of a rate increase for at least two more meetings, and it was felt now that an increase in June couldn’t be ruled out or in at this juncture.  It will depend on future data, but for a rate hike to occur, two conditions need to be met:

  • Further improvement in the labor market needs to be seen by the FOMC.
  • Committee members need to become reasonably confident that inflation will move back to its 2 percent objective over the medium term.

In the statement, the assessment of economic growth was downgraded from “expanding at a solid pace” as of the prior meeting to “having moderated somewhat.”  The main headwind compared to conditions seven weeks ago is that “export growth has weakened,” and dollar strength points to even more of that factor in the future.  The dollar’s performance featured prominently in the Q&A at the press conference.  One reporter asked for a quantification of the likely impact of the dollar’s movement.  Yellen didn’t take that bait, but I will.  An inexact rule of thumb for judging the change in an economy’s monetary conditions of a given shift in the currency stipulates that one first needs to compute the share of GDP that exports and imports represent, then take the reciprocal of that ratio, and a trade-weighted change of that size is likely to exert the same effect as a one percentage point change in the central bank interest rate.  So with trade equaling about a sixth of U.S. GDP, a 6% trade-weighted rise of the dollar is like a 100 basis point advance in the fed funds rate, and a the 12% trade-weighted dollar appreciation since the December 17 FOMC is like having the interest rate already go up 200 basis points.  Be forewarned, however, that this a back-of-the-envelope calculation, and with the dollar being the world’s dominant reserve currency and a major invoicing currency for trade, the real impact probably equals an interest rate change of less than two percentage points. 

I found the forecast sheet to be the most interesting part of the FOMC presentation.  In the dot-plot diagram of the level individual FOMC members expect the appropriate end-year fed funds rate levels to be, the median level for end-2015 was reduced by 25 basis points to 0.625% compared to estimates submitted three months ago.  The median projected rate level at end-2016 of 1.875% is down from 2.50%, and the median end-2017 level fell to 3.125% from 3.75%.  Only four Committee members in December thought the rate should be lower than 2.0%, but now eleven do.  Regarding projected GDP growth, unemployment, and inflation by the FOMC staff, GDP forecasts were revised downward for 2015, 2016, and 2017, the jobless rate was lowered for all three years but also for the long-run tendency, and the personal consumption price deflator was slashed considerably to a 0.6-0.8% range from 1.0-1.6% before.  Smaller downward tweaks were made to the inflation forecasts for the two out-years, and core inflation this year was also revised lower to 1.3-1.4%, that is significantly under the 2% target. 

With projected inflation getting revised lower, one can naturally see reservations arise about becoming more confident in the eventual securing of a 2.0% inflation trend in the longer run.  An additional inconsistency that seemingly has to be resolved is that while survey evidence of people’s expectations of future inflation remain in line with the Fed’s 2% target, market-derived measures that compensate for the erosion of value through inflation imply a trend that is well below 2.0%.  A question about the accuracy of survey data related to inflation expectations was not directly answered other than to say that such information are but one of many sources of empirical evidence upon which Fed decisions are based and can be very helpful in revealing the likely direction of price trends.

The most useful lesson I took away from today’s FOMC communication was the strong reaction of the market.  Like her predecessor, Chair Yellen goes into a day like today with a notion not only of what message she wants to share about the economy and Fed policy but also of how she hopes the market will react if correctly understands that message.  And at times when markets respond differently than hoped, central bankers tend to find ways to signal the difference.  Today’s market reaction was strong, so if Fed officials are displeased, look for a correction in the next week or so.  Otherwise, we can assume that the safety remains on the Fed tightening weapon.  Beyond the first shot, moreover, officials are not expecting to be aggressive.  They’ve even said again and again that rate levels will likely crest below what was normal in prior tightening cycles.  For currency market junkies, it’s nice to see the dollar’s performance riding in the front seat of the policy car.  That’s happened very seldom in the past.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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