Markets are trying to come to terms with a media blitz this week from senior Federal Reserve officials who are talking up the odds of an April rate hike. While most of the 12 regional Fed presidents are supporting the idea of just two rate hikes this year, fully one third of them think that a rate hike four weeks from now would be a good idea.
This chatter has had the immediate effect of strengthening the dollar, which is worth more if rates increase. This has had a knock-on effect on stocks, oil, and commodities, as well as on the economies of emerging market nations. This begs the question: If markets move this much on just the rumors of an imminent rate hike, how will they react if it actually comes to pass?
St. Louis Fed president James Bullard has been the point man in alerting Wall St. that an April rate hike is not off the table. Speaking on Bloomberg TV this week, he said “You get another strong jobs report, it looks like labor markets are improving, you could probably make a case for moving in April.” He warned that moving too late could be disastrous: ""I do think you want to be edging closer and closer to something of a more normal setting so you don't get stuck in this zero-rate environment the way Japan did."
Bullard also said that there had been a "credible case" to hike rates in March, but it was decided to hold off and see if economic conditions continued to improve.
Last Monday was a Fed doubleheader, as both Atlanta Fed president Dennis Lockhart, and San Francisco Fed president John Williams spoke to the public regarding the chances of an April rate hike. When asked when the next interest rate hike would be, Lockhart said “In my opinion, there is sufficient momentum evidenced by the economic data to justify a further step at one of the coming meetings, possibly as early as the meeting scheduled for end of April.”
On the question of the timing of the next rate hike, Williams said “All else equal, assuming everything else is basically the same and the data flow continues the way I hope and expect, then April or June would definitely be potential times to have an increase in interest rates.” He disagreed with Bullard's assertion that there was a credible case for a March rate hike, noting “The evidence on inflation was not that convincing, even for me.”
Perhaps the most hawkish opinion came from new Philadelphia Fed president Patrick Harker, who actually said "I think we need to get on with it." While agreeing with his colleagues that a March rate hike would have been too soon, he thinks the economy is now ready for an April rate hike: "This economy is really quite resilient to a lot of the headwinds (including the strong dollar), so if that continues I would be supportive of another 25 basis point rise."
Fed spokespersons are also emphasizing a point that they have discussed off and on for the last year: It isn't the end of the world if inflation overshoots the Fed's 2% guidepost. In fact, a paper last month from the San Francisco Fed put forward the notion that letting inflation run up to 2.5% or so would actually help the economy recover faster.
James Bullard chimed in this week on the subject. noting that “the odds that we will fall somewhat behind the curve have increased modestly,” but that he had faith the Fed could get back ahead of it. He also gave more insight to his views on inflation. "I don’t have any problem with overshooting. I found the whole discussion about this issue, if you’re at 1.5 percent, you’re missing by half a percentage point. If you’re at 2.1 percent, you’re missing by one tenth. It’s better to be at 2.1 than 1.5. You want to be as close as you can be to your inflation target, but it’s a symmetric target. You can be above or below. There’s no problem with that. "
Richmond Fed president and outspoken hawk Jeffrey Lacker said that “Inflation has been held down recently by two factors, the falling price of oil and the rising value of the dollar, but neither factor is likely to depress inflation indefinitely. After the price of oil bottoms out, I would expect to see headline inflation move significantly higher.” Perhaps using estimates on how long it will take to work through the global oil glut, Lacker said that in inflation stayed below 2% for the next five or ten years, it still would not be inconsistent with the Fed's expectations.
In addition to saying that Fed is expecting a small overshoot on inflation, St.Louis Fed president James Bullard criticized the way the Fed gives forward guidance. One thing in particular that he cited as "counterproductive" was the dot plot that is released every quarter after a FOMC meeting. This chart has a dot for each Fed official's opinion of where interest rates should be in the short and medium term. Bullard noted that Alan Greenspan among others never used a dot plot as forward guidance, he said "[T]hey never gave any kind of indication about where rates were going to go and that, I think, served a purpose because it kept people focused on, what is the data really justifying at this point, and it let market expectations move around as the data came in. But now we’ve got a dot plot that’s got these kind of lines, median lines on it, and I’m not quite sure that’s really what we want to be doing."
Derek Holt, vice president of economics at Scotiabank agrees. In a letter to clients, he said "The Federal Reserve should cease to publish its 'dot plot' of fed funds forecasts and end attempts at providing policy rate guidance. The exercise has been marked by monumental forecast inaccuracy measured not in mere basis points on individual rate moves but in orders of magnitude on full cycle guidance, and guidance has not helped markets to formulate views on near- to medium-term policy exercises."
Does Yellen Have To Sing?
One reason that Fed officials may be pushing the April rate hike meme so forcefully is the market's assumption that, if Yellen isn't holding a press conference afterward, there's no chance of a rate hike that month. Following this logic, the first chance of a rate hike would be in June.
Bullard sees this as another way that the Fed is dropping the ball when it comes to forward guidance and market expectations. “It’s really hurting us that we’ve got this kind of alternate meeting thing. I think we should make all meetings ex-ante identical. You should have press conferences at every meeting. I’ve long been an advocate of this.”
This follows on testimony by chairperson Yellen where she consistently says that a rate hike could be announced at any FOMC meeting. What do you think? Vote in our poll and let your thoughts be known!
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