Thursday, May 19, 2016

What's Going On At The Fed

On May 18th the Federal Reserve released their April meeting minutes which you can read here.  I found this meeting to be particularly interesting.  Here is an excerpt from the minutes with certain sections I have highlighted for emphasis.

"Members again agreed that, in determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee would assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment would take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee agreed that it would carefully monitor actual and expected progress toward its inflation goal. The Committee expected that economic conditions would evolve in a manner that would warrant only gradual increases in the federal funds rate, and that the federal funds rate was likely to remain, for some time, below levels that were expected to prevail in the longer run. Regarding the possibility of adjustments in the stance of policy at the next meeting, members generally judged it appropriate to leave their policy options open and maintain the flexibility to make this decision based on how the incoming data and developments shaped their outlook for the labor market and inflation as well as their evolving assessments of the balance of risks around that outlook. It was noted that communications could help the public understand how the Committee might respond to incoming data and developments over the upcoming intermeeting period. Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low. "

In many past meetings the Fed stated they were "data dependent" in making their decisions to raise rates.  Recently they have begun to talk about "expected economic conditions" in their public speeches, talks, and formal meetings. Basically they are saying they will increase interest rates on the expectations that conditions will improve.  This is a big divergence from the previous policy of waiting for the data to confirm their decisions.  It's akin to a restaurant owner expanding in a small town on the hope one day there will be even more people to eat there. Um no one runs their business like that.

Next Fed officials stated they want inflation to come in at their 2% goal, but inflation has not been near their goal at all recently despite receive a strong report this week. So inflation isn't even near their goal, nor has it been for much of the recovery, but they expect it to be back to normal soon. Now it's been a few years since my Economics 101 class, but usually strong inflation warrants higher interest rates, not below expectation inflation.

In the very next sentence they stated economic conditions are evolving in such a way that would only warrant gradual increases in the federal funds rate. In April I mentioned the Fed would be gradual in it's increases and that's confirmed. I also said in that same post and last week the Fed might be quicker than anticipated if growth picked up making the rate increase trend rather choppy. This appears to be the case and I'm thinking the Fed is more likely now to raise rates in June to avoid having to raise them closer to election time.  Remember they are starting to base their decision off "expected economic conditions"That's a good excuse to stay ahead of the political game.  I still expect the overall trend to be very gradual, and the Fed is confirming that viewpoint.  

Overall I'm seeing some holes in this statement, and some big ones at that.  If you read the whole statement you'll see plenty of notable exceptions to strong growth.  Yet there is a strong push to raise rates.  I think something else is afoot here.  Either be it political or something more global it's happening and the Fed can see it. We must also consider the effects of low rates on pension funds, insurance companies, and high rates on government finances.  The Fed has finally reached the point where they have to raise rates.  They were so low for so long and growth barely ever reached their targets.  Higher rates have substantial effects across many sectors which we will continue to discuss here in future posts.

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