The Fed: Fed speeches show readiness to raise rates next month and a wariness about next recession
Federal Reserve Chairwoman Janet Yellen began the week by complaining that sometimes her colleagues talk too much.
Read: Yellen: It’s confusing with so many voices on the FOMC
But Fed watchers don’t seem to mind. They say they gleaned two important conclusions from a flurry of public appearances by central bankers this week.
The first point is that the central bank is set to raise rates again in December.
“We have pretty much hit the all clear for a December rate hike,” said Thomas Simons, economist at Jefferies.
The low inflation readings seen since the spring “don’t appear to perturb them,” Simons said.
See: Fed’s Mester says she is not troubled by low inflation
Omair Sharif, senior U.S. economist at Societe Generale Group, agreed.
“Generally speaking, December is almost a foregone conclusion,” he said.
San Francisco Fed President John Williams told reporters on Thursday that a December rate hike was “perfectly reasonable,” according to Reuters. Markets see a greater than 90% chance of a rate hike at the Dec. 12-13 meeting.
This would be the fourth rate hike in the past year, a much faster pace that the one rate hike over the prior 12 months. The Fed last met earlier this month and held interest rates steady. Minutes of that meeting will come on Wednesday.
Read: Fed calls U.S. economy ‘solid’ December rate hike still on track
“The economy is chugging along. It is not brilliant, but it is doing better than we thought it would after the hurricanes,” said Terry Sheehan, an economist at Oxford Economics.
“It is not untenable to say the Fed needs to remove another increment of accommodation,” she said.
The other key point from the speeches was that the central bankers are concerned they might not have all the tools they need to combat the next recession.
In the past, the Fed has been able to slash short-term interest rates, often by up to 5 percentage points, when the economy has stumbled.
But that is unlikely to happen in the next downturn as short-term interest rates are now just above 1% and the Fed doesn’t expect them to rise above 3% until the end of 2020.
The discussion can get complicated, but essentially the Fed could end up tolerating slightly higher inflation and interest rates, Sharif said.
At the moment, the Fed is following an inflation targeting approach, trying to get inflation up to a 2% target. But inflation has remained stubbornly below that level basically since the end of the Great Recession.
“They want to think about what to do about price stability, how it’s measured and how to shape expectations,” Sharif said.
Atlanta Fed President Raphael Bostic told reporters this week that he thought the shift in leadership from Yellen to Jerome Powell was a good time to examine the central bank’s strategy, according to Bloomberg.
“The new guy comes in and they are able to really think about, how should this work, how do I think this should work and is it compatible with where we’ve been and where we are trying to get to,” Bostic said.
Cleveland Fed President Loretta Mester told reporters that Fed should follow the lead of the Bank of Canada, which formally reviews its strategy and policy tool every five years.
“We’ve been through the crisis. We know the challenges it posed to monetary policy,” she said.
John Williams of the San Francisco Fed has taken the lead on the policy re-think.
“History teaches us that a recession will come at some point, and prudence demands we use this time of relative economic calm to plan for the storms ahead,” Williams said in a speech on Thursday.
Williams wants the Fed to change its strategy to “price-level targeting” which would see the central bank allow inflation to remain above the 2% target to “make up” for periods when it was too low.
It would help combat a recession because financial markets would be convinced the Fed was going to keep rates “lower for longer” and refrain from running up longer-term Treasury yields at the first sign of a recovery.