Federal Reserve Manages to Communicate a Comforting Message as a New Policy Chapter Begins

December 16, 2015

The Federal Open Market Committee released a statement confirming the universally held belief that the federal funds rate would be raised by 25 basis points and that the balance sheet of the central bank would not be squeezed just yet.  The statement was accompanied by fresh forecasts going out to 2018 that were modified only trivially, and these releases were followed by a 70-minute press conference given by Chair Janet Yellen.  Over the hour and 40 minutes between the statement and the end of the conference, U.S. share prices rose 0.9%, the 10-year Treasury yield stayed at 2.29% on balance, the dollar rose 0.4-0.5% against the yen and euro, and oil slid by a further 0.8%.

Yellen stressed that the Fed would not have raised its rate, albeit by only 25 basis points from a very low base, if FOMC members weren’t confident about the strength of the U.S. economy continuing and stout in their belief that lower-than-expected inflation reflects transitory factors and that inflation will indeed move much closer to target in 2016.  For further rate hikes to be engineered, members are looking for confirmation of the theory in the trends of actual inflation defined as the personal consumption price deflator as well as in measures of longer-term expected inflation, which in fact recently have slipped a bit lower.  So while progress has been made on both of the FOMC conditions for starting rate normalization, there is been considerably more good news on labor market trends than on inflation.  It is in fact the committee’s view that in the coming year the jobless rate will and should appropriately dip below 5.0% as part of the process that will correct inflation.  It is not a current intent that intervals between rate increases be always even or that the magnitude of each move be 25 basis points every time.  Data pertaining to the two mandates will guide the path.  Yellen acknowledged that economic modeling is imperfect.  Theory without eventual empirical support by the data would call for a careful interpretation of the continuing disparity.  Is inflation too low because of a continuing sequence of disinflationary shocks, because of a faulty theory, because of bad data measurement or because the basis for low inflation has in fact transformed into a more structural than transitory dynamic? 

If the Fed above all else is trying to prolong a moderate, non-inflationary economic recovery and is acting out of perceptions of sound U.S. fundamentals, investors have nothing about which to be worried.

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



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