The Fed Holds Rates, for Now (Jan. 28)

Dear Mike & Co.,

Pre-primary endorsements from Party leaders in tight contests are rare and sometimes understated.  To wit, President Obama remarks this week that HRC is as prepared to be president as any non-Vice President as anyone: “I think that what Hillary presents is a recognition that translating values into governance and delivering the goods is ultimately the job of politics, making a real-life difference to people in their day-to-day lives.”

Yesterday, House Democratic leader Nancy starting doing precisely that, assessing the centerpiece of Sanders’ platform:  “He’s talking about a single-payer, and that’s not going to happen. I mean, does anybody in this room think that we’re going to be discussing a single-payer? … We’re not running on any platform of raising taxes.” 

 Far from the cauldron of Congress and the icy campaign trail was an announcement by the Fed with implications for the overall economy and for the election year ahead.  More on the Fed’s statement and its implications below.

Please let me know if you have any questions or issue coverage requests. 

Best, 

Dana

 

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The Fed’s Statement

The Federal Open Market Committee (FOMC) of the Federal Reserve decided yesterday not to raise rates in January.  Last month, the Fed voted to raise interest rates for the first time in nine years, setting its rate target between 0.25 and 0.5 percent.  Today’s statement reaffirmed this decision, noting that recent market turbulence had not stayed the Fed from its plan to continue “only gradual increases in the federal funds rate.”  Speculation and hope are rife that the FOMC will hold off raising rates in March and wait until June.

But the statement today indicated no change in the Fed’s plan for previously outlined  rate increases, four 0.25 percent increases this year, with total increases of one percent this year and next.  However, the FOMC is largely comprised of dovish voters, who may change tack if current market corrections continue.

Market Reaction

The Dow Jones Industrial average is down from 17.759 on December 16 to 15,951 today; the S&P 500 has declined from 2,073 to 1,879 over the same period.  The

Fed however expressed confidence in continuing economic growth, calling low inflation and the decline in energy prices “transitory” and predicting 2 percent inflation in the medium-term as energy prices rise again.

In a nod to beleaguered investors, the Committee wrote that it “… is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.”  So the Fed has, unusually, acknowledged the global scope of its deliberations.  FOMC also indicated a focus on “labor market indicators [which] will continue to strengthen.”

For now, though inflation is running just 0.4 percent, well below its two percent target, the Fed has not disavowed its plan to raise rates four times this year.   This cannot be welcome to global equine markets.  Domestic and global capital markets have already lost roughly ten percent since the December rate hike.  Fed policy may be having a decelerating effect on growth and so could be a marginal drag on Democratic prospects.

New FOMC Members

The FOMC is made up of rotating board of seven voting members taken from Board of Governors members as well as regional bank officials; these members rotate on an annual basis at the first meeting of each year.  The 2016 committee members are listed below (identified as”hawks,” those favoring tight monetary policy or “doves,” supporting more accommodative policy).

• Janet L. Yellen, Board of Governors, Chair (dove)
• William C. Dudley, New York, Vice Chair (dove)
• Lael Brainard, Board of Governors (dove)
• James Bullard, St. Louis (hawk)
• Stanley Fischer, Board of Governors (hawk)
• Esther L. George, Kansas City (hawk)
• Loretta J. Mester, Cleveland (hawk)
• Jerome H. Powell, Board of Governors (swing)
• Eric Rosengren, Boston (dove)
• Daniel K. Tarullo, Board of Governors (dove)

New members this year are James Bullard, Esther George, Loretta Mester, and Eric Rosengren.  The FOMC consists of 12 voting members, with two nominees awaiting Senate confirmation.  A shift in the balance of power between hawks and doves may occur but the doves hold a slim majority for now.

Code Breaking

Fed watchers have made an art form out of reading between the lines of these policy releases, even the most benign of which can cause huge swings in markets (the Dow dropped over 200 points in the wake of today’s release).  Fed statements are famously difficult to parse but one point was unmistakable: the Fed is keeping a close eye on the labor market — employment and participation rates, wages, etc. — as a leading indicator for inflation and overall growth perhaps more than any other variable.

Campaign Consequences

None of the candidates has commented on today’s release, not surprisingly, but the policy may draw ire from some on the right, who oppose fiat rate-targeting (though it took no action today) and the left, where lowering rather than raising rate is preferred (except for holders of fixed income securities).

Sen.  Sanders, true to his reputation of standing far outside the Democratic fold, has long opposed the Fed for being too involved with the bankers they are meant to be regulating.  Sanders has called for reform measures at the Fed, including prohibiting people serving on bank boards from serving on the Fed at the same time.

The Fed was confident that economic growth would continue on its steady pace, indicating strength in labor markets and downplaying both financial market reactions and diving commodities prices.  The FOMC sets monetary policy on a long-term basis; the full ramifications of their decisions aren’t felt until months or years out, so any contention that the economy is strong enough to handle higher interest rates is essentially an endorsement of macroeconomic policy in the last few years. Democratic candidates will need to hammer this point home – but it is yet to be seen if voters will understand the message that Democratic policies are responsible for the sunny outlook for the American economy, especially compared to Western Europe, Latin America, and Asia.

Below is the first sentence of the FOMC statement from yesterday, edited to reflect changes from last month’s statement:

For immediate releaserelease at 2:00 p.m. EST

Information received since the Federal Open Market Committee met in OctoDecember suggests that economic activity has been expanding at a moderate pacelabor market conditions improved further even as economic growth slowed late last year. Household spending and business fixed investment have been increasing at solidmoderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed. A range of recent labor market indicators, including ongoistrong job gains and declining unemployment, shows further improvement and confirms that underutilization of labor resources has diminished appreciably since early this year, points to some additional decline in underutilization of labor resources. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; somedeclined further; survey-based measures of longer-term inflation expectations have edged downare little changed, on balance, in recent months.