By Steven K. Beckner
WASHINGTON (MNI) – The U.S. monetary policy outlook might seem more
uncertain than ever after the Federal Reserve’s decision to stand pat at the
zero lower bound, except there is an inclination to start raising interest rates
– once Fed officials are satisfied recent financial turmoil and global
uncertainty won’t unduly impact the U.S. economy.
The Fed’s rate-setting Federal Open Market Committee made abundantly it
clear unsettled international financial conditions and global economic worries
prevented it from raising the federal funds rate from near zero, as widely
expected not long ago. And Chair Janet Yellen reinforced the message in a press
conference.
But, as shown in the latest funds rate projections, the FOMC majority still
expects to raise rates this year, though not as much as once planned, and Yellen
suggested liftoff is only awaiting clarity about how “financial and
international developments” will affect the U.S. economy.
Although those developments obviously impinged on its decision-making
Thursday, the FOMC’s central focus remains the two liftoff conditions put forth
since March and reiterated in the latest policy statement: “The Committee
anticipates that it will be appropriate to raise the target range for the
federal funds rate when it has seen some further improvement in the labor market
and is reasonably confident that inflation will move back to its 2% objective
over the medium term.”
It would have been surprising if Yellen and her colleagues would have
disregarded wild swings in asset and commodity prices that erupted when China’s
currency devaluation exacerbated fears of a global slowdown.
But that does not mean that those issues will keep the Fed on hold
indefinitely.
Diverging from its usual characterization of the U.S. economy, the FOMC
said “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.”
And while continuing to call risks to the outlook “nearly balanced,” the
FOMC took the unusual step of adding it “is monitoring developments abroad.”
Yellen’s comments were laced with explanations why the FOMC had to take
into account external factors and their financial reverberations. In her opening
statement, she said, “the outlook abroad appears to have become more uncertain
of late.”
“Heightened concerns about growth in China and other emerging market
economies have led to volatility in financial markets,” she continued.
“Development since our July meeting including the drop in equity prices, the
further appreciation of the dollar, and a widening in risk spreads have
tightened overall financial conditions to some extent.”
Yellen said “these developments may restrain U.S. economic activities
somewhat and are likely to put further downward pressure on inflation in the
near term. Given the significant economic and financial interconnections between
the United States and the rest of the world, the situation abroad bears close
watching.”
Yellen said the FOMC discussed a possible rate hike, but “in light of the
heightened uncertainties abroad and the slightly softer expected path for
inflation, the committee judged it appropriate to wait for more evidence,
including some further improvement in the labor market, to bolster its
confidence that inflation will rise to 2% in the medium term.”
Elaborating, Yellen acknowledged the FOMC had “focused particularly on
China and emerging markets.”
She said the Fed has “long expected… some slowing in Chinese growth over
time as they rebalance their economy,” but said “the question is whether or not
there might be a risk of a more abrupt slowdown than most analysts expect.”
“And I think developments that we saw in financial markets in August in
part reflected concerns that there was downside risk to Chinese economic
performance and perhaps concerns about the deftness with which policymakers were
addressing those concerns,” she said.
“In addition we saw a very substantial downward pressure on oil prices in
commodity markets, and those developments have had a significant impact on many
emerging market economies that are important producers of commodities as well as
more advanced countries including Canada which is an important trading partner
of ours that’s been negatively affected by declining commodity prices, declining
energy prices.”
Yellen observed “we have seen significant outflows of capital from those
countries, pressures on their exchange rates and concerns about their
performance going forward so a lot of our focus has been on risks around China,
but not just China, emerging markets more generally and how they may spill over
to the United States.”
The Fed chief insisted she and her colleagues “don’t want to really respond
to market turbulence” and “it is certainly not our policy to do so.”
“But when there are significant financial developments, it’s incumbent on
us to ask ourselves what is causing them,” she said. “And of course while we
can’t know for sure, it seemed to us as though concerns about the global
economic outlook were drivers of those financial developments.”
But while she repeatedly explained why the FOMC had to “take into account”
global and financial developments, Yellen also took pains to remind reporters
they are not the only things it will be looking at.
“Now, I do not want to overplay the implications of these recent
developments, which have not fundamentally altered our outlook,” she said. “The
economy has been performing well, and we expect it to continue to do so.”
Yellen said “it remains the case that the timing of the initial increase in
the Federal funds rate will depend on the committee’s assessment of the
implications of incoming information for the economic outlook.”
“To be clear, our decision will not hinge on any particular data release or
on day-to-day movements in financial markets,” she said. “Instead, the decision
will depend on a wide range of economic and financial indicators and our
assessment of their cumulative implications for actual and expected progress
towards our objectives.”
Yellen did not predict a rate hike before year’s end, but pointed out that
the 0.4% median funds rate projection for 2015 implies one. And she said the
FOMC need not wait for December – the next time she’ll be giving a press
conference.
“Every meeting is a live meeting where the committee can make a decision to
move to change our target for the Federal funds rate,” she said. “That certainly
includes October (27-28)… October remains a possibility.”
There’s no question Yellen and her colleagues are more concerned about
below-target inflation. As she noted several times, “further appreciation of the
dollar” and lower energy prices have put more downward pressure on prices.
But she also said several times those inflation-dampening forces are
“transitory.” And while she said the 5.1% unemployment rate understates
remaining labor market slack, she emphasized nonetheless there has been much
labor market improvement.
Linking job and inflation objectives, Yellen said, “the labor market has
continued to improve. So a tighter labor market, a labor market moving toward
full employment is one that historically has generated upward pressure on
inflation.”
“So that bolsters my confidence in inflation,” she added.
Yellen wouldn’t take the bait when one reporter tried to get her to say
rate hikes might have to be delayed well beyond year-end. Her message was that,
for now, prudence dictated that the FOMC weigh the implications of financial
turmoil and global headlines, but that it was going to keep its eye on the
domestic ball:
“You know, I want to emphasize, domestic developments have been strong,”
she said. “We see domestic demand growing at a solid pace. The labor market is
continuing to improve.”
“I can’t give you a recipe for exactly what we’re looking to see,” Yellen
said. “But as we say, we want to see continued improvement in the labor market
and we would like to bolster our confidence that inflation will move back to
2%.”
“And of course a further improvement in the labor market does serve that
purpose,” Yellen went on. “There could be other things we would see that could
bolster that confidence. But further improvement in the labor market will serve
to do that.”
Yellen pointed out “you can see from the SEP projections that most
participants continue to think that economic conditions will call for or make
appropriate an increase in the Federal funds rate by the end of this year.”
“Four participants moved their projections into 2016 or later,” she said,
“but the great majority of participants continue to hold that view.”
Yellen said “there will always be uncertainty” that can never be “fully
resolved.”
For the time being, “in light of the developments that we have seen and the
impacts on financial markets,” Yellen said “we want to take a little bit more
time to evaluate the likely impacts on the United States.”
But that does not mean she and the FOMC are willing to wait indefinitely.