The Fed, in its press release, has let open all the options for hiking rates before the end of the year but September is still high on the agenda. The US central bank has reminded us that its decision will be data dependent and that the improvement on the labor market is the kind of data that could accelerate the decision. But on the other side, lower energy price will not hasten the convergence of inflation to the 2% target.
In other words the Fed has noticed that even growth prospects remain moderate there are stronger dynamics than in June on households and on the labor market. Imbalances are still there on the labor market but more limited than in June. Exports and investment are still a drag to a stronger expansion.
In the press release, there is a part in which the Fed gives its interpretation of the economic outlook and there is a part on monetary policy. As mentioned the first part has been changed but the second part is unchanged at the exception of one word, “some”, that has been added.
The sentence is the following: “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 percent objective over the medium term”.
The addition of the “some” word can mean that, compared to June, the situation is closer to what is expected by the Fed. This is the reason why the probability of a September hike is still strong.
Before the next Fed’s meeting (September 16 and 17) there will be 2 labor reports two inflation reports (PCE index). So there is still time for speculation but the FOMC seems to be focus on September.
Two points to be added
1 – The Federal Reserve has been communicating on interest rates hike for a long time now. It wants to avoid surprises on investors’ side. The 1994 rapid change on long-term interest rates is not what the Fed’s wants and its doesn’t want to provoke rapid adjustment as in May 2013 when Bernanke said that a monetary policy normalization was expected. To limit these types of risks the communication on interest rates hike has started a long time ago. They focus on 2015 to create a limited period for rate lift-off. If adjustments are needed on investors’ side there was room for such movements.
The Fed expects that a change in its monetary policy will not be perceived as a shock and that the yield curve will not be affected by it. As the movement was announced well in advanced, a large part of the adjustment has been made.
The Fed doesn’t want to create a negative shock on the economy. Fed’s members know that the trajectory is weak (the growth rate is only 2.2% since the trough of Q2 2009 (at annual rate)). So the economy would not be able to resist to a strong negative shock or at least the Fed doesn’t want to take this risk.
2 – The second point, not mentioned in the press release, is how the communication will change in the future. Janet Yellen has said that the fed fund’s profile will not mimic that of 2004 when there was a hike at each meeting. The Fed’s communication will have to avoid divergence in expectations and probably a more precise communication on the expected fed fund’s profile will be needed.
At the end, three points to keep in mind
The probability of an interest rate lift off in September is high (more than 50%) but the decision is still data dependent. Weak labor reports for July and August would delay the hike. So next week report will be important even if wages are not increasing rapidly.
The third point to keep in mind is that the US central bank wants to have degree of freedom in the management of its monetary policy. OK growth is not strong and inflation is way below the target but the Fed considers that the economy is solid enough to support a limited series of rate hikes in the coming months. Rates should converge to 1.5% at the end of 2015.