One of two things is going to happen. Either the US economy is or will soon be slowing on the back of already tighter financial conditions. Or the US economy will soon be slowing on the back of future tighter financial conditions as directed by the Federal Reserve.
In a worst case scenario, both of these things will happen.
And the odds of both of these things happening seems higher after this week’s FOMC meeting. Rather than being a nonevent as expected, it was actually quite exciting. We learned that the majority of the FOMC remains wedded to the idea of a December rate hike. That was made very clear with this sentence:
In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.
That was a fairly clear warning that December is really, really in play. No, really this time. They mean it. After all, a number of them are on record repeatedly saying that they expect to hike interest rates this year. I tend to wonder if they feel compelled to act on these statements? The opportunities to show their mettle are fairly limited at this point.
It also seems as if Federal Reserve Governors Lael Brainard and Daniel Tarullo were schooled hard this week. They argued publicly that they did not see reason to raise rates this year. I doubt they changed their opinions – at least not privately. But they very clearly did not change any opinions on the FOMC. Indeed, one wonders if they only hardened their colleagues positions on a rate hike this year. Consider Paul Krugman’s response to me:
Maybe, but it’s also worth noting the difference in perspective that comes from having your original intellectual home in international versus domestic macroeconomics. I would say that Brainard’s experience is dominated not so much by the Great Moderation as by the Asian financial crisis and Japan’s stagnation; internationally oriented macro types were aware earlier than most that Depression-type issues never went away. And if you read Brainard’s argument carefully, she devotes a lot of it to the drag America may be facing from weakness abroad and the stronger dollar, which acts as de facto monetary tightening
Krugman is right; I should have mentioned this. Regardless, note what key line was removed from the September statement:
Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.
Downplaying these concerns appears to be an effort to cut the knees out from under Brainard. To be sure, US markets rebounded, but have we seen much in the last six weeks to so quickly remove global concerns? I am wary to believe so with data like these:
CRB spot raw industrial price index set new 6 year low this week. https://t.co/gN9Pcbhbua
— Caroline Baum (@cabaum1) October 28, 2015
In any event, it seems reasonable to believe that the bar for a rate hike at the next FOMC meeting is fairly low. Prior to the meeting I said this:
The middle range of closer to 150,000 jobs a month—a more lackluster reading similar to the past two months—is the gray area. This is the range in which the proper application of risk management principles becomes critical. In that range—a range I find likely—the degree to which Brainard & Co. shape the debate at this week’s meeting will determine the policy outcome in December, and likely beyond.
I am thinking we now we know how little Brainard shaped the debate. Lackluster numbers seem likely to suffice at this juncture. Hence why market expectations moved as they did:
The “hawkish” shift in hike expectations (yest => today)… Dec: 34% => 46% Jan: 41% => 54% Mar: 57% => 68% pic.twitter.com/1NLZwHgivE
— Charlie Bilello, CMT (@MktOutperform) October 28, 2015
The willingness of the Fed to hike in the face of lackluster numbers is a bit disconcerting, to say the least. Lackluster numbers, by definition, indicate slower activity, and one would think that the Fed would like to see how that played out before piling on. But assuming this from Jon Hilsenrath at the the Wall Street Journal:
Mr. Fischer is among those more eager to raise rates.
It is easy to see how the Fed gets behind tighter policy. I don’t know that Brainard could easily counter the gravitas of Fischer.
Bottom Line: December stays on the table. Very much so, in fact. Indeed, in all reality the only reason market participants have not gone all in on December is because they recognize that the Fed has repeatedly cried “wolf” this year. Makes one distrustful of the Fed’s proclamations. At this juncture, my expectation is that only disappointing data prevents the Fed from moving in December. It will be interesting to see how well the Fed statement holds up to the light of this week’s GDP report and the next two employment reports.