Fed Brief

Nov 26 2014 - QE3 Goes, but ZIRP Stays

Give credit to the Federal Reserve for telling the capital markets exactly what the capital markets expected to hear out of its new policy directive:  Specifically:
  • Comforted by the improvement in labor market conditions, the Committee will conclude its current asset purchase program this month; and
  • The Committee believes it will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program
The Fed directive made a point of emphasizing the labor market improvement.  It had to as a basis for stepping aside at this juncture.  In any event, it noted that the uderutilization of labor resources is gradually diminishing, whereas the September directive said "there remains significant underutilization of labor resources."

What a difference a month makes, huh?  There was only one employment report between the September directive and today's directive.   The October employment report was a good one, yet the quick shift in perspective just goes to show that the Fed was eager to get out of the asset purchase business.

It certainly can't cite much progress on the inflation side of its mandate.   When QE3 started in September 2012, PCE inflation was up 1.5% year-over-year.  Today PCE inflation is up 1.5% year-over-year.

The Fed acknowledged in its directive that inflation in the near-term will likely be held down by lower energy prices and other factors, but that it judges the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.

That's a questionable viewpoint considering that PCE inflation has been running below its longer-run inflation target since April 2012, real hourly earnings have hardly grown, the dollar has been strengthening, and oil prices have fallen 17% since the start of the year.

It's little wonder that there is a disconnect between the market's expectations and the Fed's thinking on the trajectory for the fed funds rate.

On a related note, there was one dissent at the October meeting.  It was voiced by Minneapolis Fed President Kocherlakota, who said the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two year ahead inflation outlook has returned to 2 percent, and should continue the asset purchase program at its current level, in light of the continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations.

Something that stood out in the directive was what wasn't in the directive.  While minutes from the last FOMC meeting touched on concerns about the risks of a persistent shortfall of growth and inflation in the euro area, slower growth in China, and unanticipated events in the Middle East and Ukraine, there was no mention whatsoever of foreign matters as having any bearing on the new directive.

The FOMC reiterated that increases in the target range for federal funds could occur sooner than expected if incoming data show faster progress toward meeting the Fed's dual mandate than is now expected.    Conversely, it was stated that a rate hike would occur later than anticipated if progress proves slower than expected.

That is a long-winded way of saying the Fed remains data dependent.

The stock market shouldn't take for granted that the first rate hike won't occur until the end of 2015.  However, with inflation due to head lower in the near term on the back of sliding oil prices and a stronger dollar, it can still take for granted that the fed funds rate isn't going to be raised soon.

--Patrick J. O'Hare, Briefing.com

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