Back to Money Supply homepageI have just finished work on the final version of our news story on the Fed statement today. I’m struck by the difficulty classifying this as a hawkish or dovish statement. I think the market is wrong to see it as dovish: by identifying the conditions on which it bases its forecast of rates on hold for at least six months, the Fed has implicitly set out the factors that would lead to a rate hike within six months.
For this reason I still think it is a very faintly hawkish move. But spelling out in greater detail that your assumptions are “low rates of resource utilisation, subdued inflation trends and stable inflation expectations” is not exactly a very hawkish thing to do. It seems to me this is really an exercise in transparency and clarifying the Fed reaction function and as such is not really dovish or hawkish.
My guess is that policymakers hoped to signal an appropriate degree of uncertainty and conditionality over their rate stance without inducing more market-based tightening. There is already more than enough priced in to be consistent with some uncertainty over the Fed rate path.
The Fed managed to tweak the statement without the market pricing in more tightening. So far so good. Yet if the early price reaction means anything (and it may not) the market may not view the conditional Fed rate stance as adequate to contain inflation risk and create a two-way bet on the dollar and risk assets.
If the Fed is seen as insufficiently tough, the likelihood of inflation expectations becoming unsettled - possibly with renewed dollar weakness, rising commodity prices and asset price inflation - increases. And this could in turn lead to the Fed being forced to raise rates earlier than it would in its modal forecast.
Put another way, I have always thought that if we end up with a rate increase in the first half of next year it is more likely to be because something went wrong - the Fed failed to convince the market that it was credibly vigilant on inflation - than because something went right (ie we get a big upside growth surprise.) Such is the circularity of central bank credibility.
Last word on further statement changes. This is the first, not the last change to the rate guidance. It will be gradually amended over time as the probability of rate increases around and before a rolling six month horizon rises. But the Fed may have bought itself enough time with the changes today to delay grappling with the more sensitive issue of shortening the time frame over which the guidance applies from eg an “extended period” to “some time.”
I can see the FOMC wanting to postpone this issue until some time into the New Year, with the February Humphrey Hawkins testimony offering a natural opportunity to take stock of the incoming data and if appropriate pave the way for dropping the “extended period” phrase.
The question is whether the market gives them the luxury of waiting this long.
Tags: extended period, fed, FOMC, interest rates
Leading economists discuss topics raised by Martin Wolf, the FT's chief economics commentator, and others.