Market observers are parsing every comment from the Federal Reserve (Fed)’s most recent statement and Fed Chair Janet Yellen’s accompanying press conference, trying to determine where the Fed’s words fall on the “dovish” to “hawkish” spectrum.
If I had to weigh in on the debate, I’d say the September Federal Open Market Committee (FOMC) policy statement was “hawkish.” But more importantly than such nomenclature, I believe there were five signs in the statement that the anticipated pace of policy rate hikes is going to be quicker than markets have expected.
Toned down “dovish” phrases. While the September statement retained both “keyword phrases” that are interpreted as highly dovish (“maintain the current target range for the federal funds rate for a considerable time” and “significant underutilization of labor resources”), Fed Chair Yellen appeared to dilute the strength of the “considerable time” language in her press conference, implying that a “considerable time” could be a shorter time period than many expect.
Back in March, Chair Yellen, perhaps mistakenly, said that a “considerable time” was six months. Then, at her September press conference, she said “a considerable time” isn’t mechanical, shouldn’t be read explicitly in calendar terms, will be data dependent and could come sooner than many expect. In other words, it could be three months, or if data weaken, it could be 12 months. Given that current economic data are solid, as the Fed acknowledges (see more on that below), a “considerable time” is likely to be shorter rather than longer. In other words, to me, Chair Yellen’s comments go a long way toward weakening the Fed’s dovish language.
Revised estimates of the path of policy rates. A bit incongruously with the aforementioned key dovish statements, the FOMC signaled a meaningful upward revision in the Fed funds policy rate for the year-end of both 2015 and 2016.
Acknowledgment that the economy is improving. I anticipate that the weak August payroll report will be revised higher and that inflation should firm. Along with their revised expectation of the path of policy rates, Fed officials seem to be on the same page as me. They acknowledged the broad-based tightening in employment conditions over the past several months as well as today’s stable inflationary conditions, and they released updated economic projections.
While Fed officials believe real gross domestic product (GDP) will come in lower than expected in 2014 and 2015, the FOMC members acknowledged that the unemployment rate is likely to decline more rapidly than anticipated. Further, their inflation projections remained fairly stable, trending toward the long-run goal of 2% near the end of 2017.
An increasingly active debate about the future path of policy rates is underway at the Fed today. The most recent statement made it clear that there’s increasingly active debate within the FOMC over the appropriate path of interest-rate policy given how far the economy has come.
As I previously suggested would likely be the case, Dallas Fed Reserve Bank President Richard Fisher has joined with his Philadelphia Bank colleague Charles Plosser in dissenting from the policy statement as written. These FOMC members believe that the economic recovery places the Fed closer to its policy goals than the September statement would suggest, a sentiment I wholeheartedly agree with.
A refined set of principles for rate normalization. Finally, the FOMC clearly instituted a refined set of principles for the process of rate normalization, suggesting that normalization is very much part of its thought process today. This is despite Chair Yellen’s suggestion in the press conference that we should not take the policy normalization principles that way. Chair Yellen “doth protest too much, methinks,” on that count at least, to quote The Bard.
The upshot of all the above: The Fed is closer to its stated policy goals, and thus to rate normalization. I still believe that the Fed is likely to begin rate normalization sooner than many expect, possibly as early as March and very likely within the first half of 2015.
Though it’s important to note that while the Fed will likely move faster than many anticipate, given the pace of economic growth and its targeted objectives, the pace of normalization and the ultimate destination of rates will be slower and lower than in past hiking cycles.
The bottom line: I’ve grown skeptical of the utility of excessively low policy rate levels, so I’m optimistic that they will be gone sooner rather than later, particularly as the economy is on a solid path.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The Blog. You can find more of his posts here.