A MISSING WORD MIGHT SPEAK VOLUMES
Fed’s removal of ‘only’ in rate statement ignites speculation, writes Joe Chidley.
If your goal is to communicate that everything is under control, don’t change your script too much or too often. That’s the rule U.S. Federal Reserve Chair Janet Yellen and her fellow members of the Federal Open Market Committee followed on Wednesday, when they hiked the target interest rate for the second time in three months: by far most of the words in the FOMC’s March statement were the same as the one it put out in December.
But there was one little change — only four letters — that might end up speaking volumes.
In December, the FOMC said this: “The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate.”
This time around, it left something out. It removed the word “only.”
Surely this change must be significant, right? So let’s play interpreter, and indulge in some rampant speculation over what the missing “only” really means.
Interpretation 1: The elision is a hawkish sign, though a minor one. Let’s just take this for granted. The fact that Yellen went to such lengths to downplay its hawkishness proves that she recognized it could be interpreted as hawkish. And so we shall.
Interpretation 2: The simplest interpretation is that the missing “only” reflects a subtle change in stance toward future rate increases; that is, the Fed is leaving itself room to hike more quickly than “gradually” down the road. This seems obvious. Never mind that Yellen, in her post-meeting comments, sort of pooh-poohed this by framing the probable rate increases as prophylactic measures, capping inflationary pressures so as to prevent bigger, more disruptive hikes down the road. Which brings us to …
Interpretation 3: Maybe, by emphasizing the need to get ahead of inflation, Yellen is only highlighting the possibility that inflation might rise faster than the Fed expects and force more aggressive action.
How could that happen? True, there are few signs of overheating in the economic data. Inflation-adjusted consumer spending fell in January by the most since 2009; the personal consumption expenditures index, the Fed’s preferred measure for inflation, rose by 1.9 per cent year over year, just below the two-per-cent target. On the other side of the equation are the plummeting U.S. unemployment rate (down to 4.7 per cent) and the surprise job creation data for February, which beat expectations by 45,000 jobs.
Still, there is one big potential driver of unchecked inflation. And when he’s not in Mar-aLago, he sits about a 15-minute walk away from the Federal Reserve building in Washington, D.C., in the White House.
Donald Trump’s promises to ramp up government spending, combined with tax cuts, combined with some kind of tariffs on imports (at least from countries he doesn’t like), would only add to the inflationary forces already at work. If he manages to get his policies done — which is not at all certain — the Fed might not be able to limit itself to “only” gradual rate increases.
You could say that the Fed’s answer to such speculation is to not answer it. Yellen said that the FOMC’s outlook did not take into account potential changes in fiscal policy, acknowledging “great uncertainty” over them. Wednesday’s “modest adjustment” of the federal funds rate was all because the Fed sees the economy progressing as expected. It wasn’t about Trump. (Yellen didn’t use his name.) When it comes to fiscal policy, she said,
The simplest interpretation is that the missing ‘only’ reflects a subtle change in stance toward future rate increases.
“we have plenty of time to see what happens.”
Which at least leaves the door open for more-than-gradual increases down the road.
Interpretation 4: The most radical reading would be that the Fed no longer considers rate increases the only policy option for realizing its goals. Maybe it could use gradual hikes and more direct measures to reduce money supply. For instance, it could start unwinding its humongous position in Treasuries and mortgage-backed securities — a US$4.5 trillion hangover from the financial crisis. That move could really get the hawks flying. It would be quantitative easing in reverse, and could set off Taper Tantrum 2.0 on the markets.
Could it happen? Yellen reiterated Wednesday her view that the Fed balance sheet should be normalized “gradually over time” — just not yet — and that the rate target remains the “key active tool of policy.”
But FOMC member James Bullard, president of the St. Louis Fed, has recently been floating the case for unwinding more quickly. His rationale is that normalizing the balance sheet (that is, selling bonds and securities, effectively reducing the money supply) in relatively good times would create room for quantitative moves if the economy goes south. He also points out that current Fed policy is artificially flattening the yield curve, pushing up short rates while depressing the long end.
Now, after reading all this, you might agree with Janet Yellen that the missing “only” is not worth much thought. She has said it’s only an indication that Fed expectations for the economy have firmed up, and that its previously stated path of gradual increases is the right one. In short, she said, “I think this is something that shouldn’t be over-interpreted.”
But heck, where’s the fun in that?