Preview of the April FOMC Meeting
This week’s Federal Open Market Committee (FOMC) meeting will reveal the widening divide between those who are anxious to raise interest rates and those who are not. Debate over the timing of rate hikes is growing more heated, along with movement between camps. Look for the number of dissents on the committee to rise; at least two regional Fed presidents have almost pledged to dissent, while another appears to be waiting in the wings. Two dissents would not surprise financial markets, but three would raise eyebrows.
Dissents tend to be driven by the presidents; we do not expect a dissent among the governors, whose votes carry more weight, despite differences in their opinions. When presidents dissent, they usually represent at least one other participant who cannot vote at a given meeting.
Bottom Line: The statement will err on the dovish side and leave the door open to a June rate hike. The broad spectrum of views among FOMC members makes forecasting more complex than ever. For those willing to take a deeper dive,
Chair Janet Yellen leads the members who want to delay raising rates. This group includes Governors Brainard and Tarullo and Presidents Dudley, Evans and Lockhart, who recently reneged on his stance wanting to raise rates. Yellen and her camp support the Fed being more reactive to the data and believe:
- The Federal Reserve must hedge the downside risks, given how close we are to the zero bound on rates. The Fed’s ability to stimulate if the economy falters is limited, while historically it has been better at reining in inflation. A reversal back to zero so soon after liftoff would undermine the Fed’s credibility.
- The inflation target is symmetric: A period of below-target inflation should be followed by an equally long period of above-target inflation. They are much more comfortable with an extended period of inflation above the 2% target.
- Slack in labor markets is still substantial, which means that we still have room to reengage the under- and unemployed.
- Risks to inflation are to the downside. Wage gains remain too low and inconsistent to support a sustained rise in inflation, while growth elsewhere in the world is fragile at best. Falling expectations could derail and undermine growth in an improving economy. We may be seeing the inverse of the 1970s, with inflation expectations slowing even as the economy firms; this could then trigger stagnation.
My own take is that the falling expectations argument is a bit of a ruse to justify overshooting. Anyone who has spent time with consumers knows they still worry more about prices accelerating, especially when it comes to rents and health care premiums.
On the other side, those nipping at the bit to raise interest rates are led by Vice Chair Stanley Fischer and include Presidents Mester and George, who are likely to dissent. Bullard also looks like he is willing to dissent, but he has not been steadfast in his views. Lacker’s in this group, too. They want the Fed to be more preemptive:
- A reversal to zero so soon after liftoff would not undermine the Fed’s credibility.
- The inflation target is more of a ceiling than it is symmetric; any sustained period with inflation above 2% would undermine the Fed’s inflation-fighting credibility.
- Unemployment is near or at the economy’s potential, so improvements in the participation rate from here will be limited.
- This group also uses the 1970s to support their view that inflation expectations could rise rapidly and trigger a vicious cycle of inflation amidst stagnation. The recent deceleration in productivity growth is particularly worrisome, as it suggests wages need not accelerate much for inflation to flare.
I also have my doubts about this scenario. Nearly 80% of wages were tied one way or another to the consumer price index (CPI) in the 1970s with cost-of-living adjustments (COLAs) given to blue- and white-collar workers alike. Those links to CPI broke down in the 1980s and disappeared in the 1990s.
A third group straddles the middle. It includes Governor Powell and new presidents Kaplan and Kashkari. Kaplan, who replaced Fisher, has kept his cards close to his vest; he was brought on to tone it down a bit after the outspoken Fisher years. Kashkari has focused his comments on dismantling the big banks, not on rate hikes. Harker called for rate hikes to start in late March, but took on a more cautionary tone in mid-April. Williams is also in the middle, despite recent comments supporting a rate hike. [He was Yellen’s research director when she headed the San Francisco Fed and is unlikely to challenge her openly.] Rosengren has voiced a concern that financial markets are not pricing in enough rate hikes over the next several years; many misinterpreted that as hawkish.
Financial markets have priced in fewer rate hikes than the Fed has for years; however, they were right and the Fed was wrong. The Fed has consistently overpredicted growth and inflation, along with the trajectory of rate hikes. It is unclear that the Fed will suddenly be correct, although it would be welcome news if it meant a hotter global economy.
Note: For a list of voting and nonvoting members of the April Fed meeting, click here to go to the Fed’s website.