MARKET UPDATE September 17, 2015

FOMC Hedges Downside Risks

Posted by Diane Swonk on September 17, 2015

The Federal Open Market Committee (FOMC) delayed liftoff today in response to concerns about growth abroad (read: China) and the likelihood that inflation will move lower before it moves higher. The central tendency of members in the meeting revealed their actual concerns (which provide the rationale for their decisions) that growth and inflation could both be weaker than they had previously forecast. Moreover, the ranks of doves increased, with two additional participants moving away from the Federal Reserve’s deep-seated hope to raise rates in 2015. Now there are four instead of two participants looking to delay liftoff until 2016 or later.
Also notable is that one participant actually called for short-term rates to move negative. That is an extremely aggressive stance. I am guessing it is the work of President Narayana Kocherlakota of the Minneapolis Fed. He has been outspoken about his concern that inflation is too low and could move lower. Kocherlakota will be leaving his post at the end of the year. (I.E., it is easier to be provocative when you are walking out the door and are not going to have to deal with backlash within the Fed system for much longer.)


As expected, President Jeffrey Lacker of the Richmond Fed dissented. He had been outspoken about his preference for a September rate hike in recent weeks and all but promised to dissent if the Fed opted to delay.


It is extremely important to understand the context in which this decision was made. The Fed staff opened the meeting with their outlook for the U.S. economy and the downside risks that the economy faces. Those scenarios likely showed that the economy could slow below its potential next year and that unemployment could rise. That is in addition to further downward, near-term pressure on inflation. Fed Chair Janet Yellen no doubt used those downside scenarios to argue that it was better to wait than to move and have to reverse course later. Too many central banks have moved too soon, only to lose what little ability they had left to support the economy.


Separately, there is a concern that liftoff itself will add to market volatility with unintended consequences for broader financial market conditions. This further underscores the need to be cautious when uncertainty in global financial markets is already elevated. (Read my September newsletter on this.)


Bottom Line: We are expecting the consumer to remain resilient and wages to pick up in the fourth quarter. There will not be enough data or certainty to justify liftoff in October. This leaves the option open for liftoff in December. That said, the ground beneath us is still shifting; the Fed will shift with it. The probability that the Fed waits until 2016 just went a little higher. I have to admit: I am sympathetic given the breadth of downside risks we are now facing. Data-dependency on the Fed’s part includes how shifts in today’s data influence the Fed’s forecast for the U.S. economy. Weak growth abroad, a strong dollar and recent market turbulence have clouded that outlook in recent months.

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