The Federal Reserve began its two-day Federal Open Market Committee (FOMC) meeting on Tuesday.
The big question everyone is asking is whether or not the Fed should — or will — drop the phrase “considerable time” from its policy statement on Wednesday.
And the members of Pace University’s national championship monetary policy team have a simple, one-word answer to this question: “No.”
“We just don’t see a need to change the language,” Pace seniors Kelsey Berro, Jordan Jhamb, and Julia Mikhailova told Business Insider in an interview last week.
“Considerable time” is the phrase the Fed has used to describe the period between the end of quantitative easing the first hike in the Fed’s benchmark Fed funds rate. Fed Chair Janet Yellen once quantified it as around six months.
Back in September, Wall Street economists started predicting that the phrase would be dropped from the Fed’s policy statement as the central bank closed in on the end of its quantitative easing program. But the phrase, which the market has taken as implying that interest rate hikes are at least six months away, remained in both the September and October policy statements.
Ahead of Wednesday’s statement, which is set for release at 2:00 pm ET and will be accompanied by a press conference from Fed chair Janet Yellen at 2:30 pm ET, Wall Street is again calling for the exclusion of the phrase from the statement.
The Pace Outlook
The Pace team — which beat teams from Princeton and University of Chicago — notes that the phrase “considerable time” might be giving the market unclear signaling. But they warn if the phrase goes away completely the market will be completely directionless.
But as the Pace team sees it, “if ‘considerable time’ is taken out of the statement, then the June 2015 meeting gets targeted,” as the first time the Fed would raise rates, which for Pace strips the Fed of the policy flexibility it’s been seeking to maintain.
And if the Fed were targeting June 2015 on its own, leaving “considerable time” in the statement would still be appropriate, Pace said.
As part of its championship-winning policy recommendations, Pace suggested the Fed stress data dependency in its forward guidance. Additionally, Pace recommended that the Fed hold a press conference which each policy announcement, as the market currently expects the Fed would only raise interest rates at a meeting that is followed by a press conference from chair Yellen.
Press conference meetings, however, are only held four times a year: in March, June, September, and December.
And as the Pace team said, “You can’t be data dependent if you can only start to raise rates four times a year.”
The Wall Street Outlook
According to a November note from JPMorgan’s Michael Feroli, the phrase “considerable time” has been “neutered” after the Fed’s last statement included language implying that faster progress towards the Fed’s labour and inflation goals could bring earlier rate hikes, while slower progress would bring later rate hikes.
In a note to clients ahead of the two-day FOMC meeting which kicks off on Tuesday, Goldman Sachs economists Sven Jari Stehn and David Mericle wrote: “We expect the FOMC to modify its ‘considerable time’ forward guidance. One possibility would be to state that the committee will be ‘patient’ in raising the funds rate until it is clear that the economy is on the path to achieving the FOMC’s goals.”
Stehn and Mericle surmise that the Fed’s reformulated guidance could take its lead from Boston Fed President Eric Rosengren’s recent formulation:
“Based on its current assessment, the Committee expects to be patient in beginning the normalization of the target range for the federal funds rate until it is clear that the economy is on the path to achieving both the 2 per cent inflation target and maximum sustainable employment.”
Maury Harris at UBS also expects that the Fed will drop the phrase “considerable time” as part of a three-part effort by the Fed to prepare the market for a June 2015 interest rate hike.
Harris expects that the Fed will provide a “reasonably upbeat assessment of economic conditions with a focus on the positive impact of declines in energy prices,” as well as an updated “dot plot” that continues to imply a June 2015 rate hike and, “likely, a more aggressively consistent path in 2016 as well.”
The Big Picture
As of Monday, data from CME Group shows that the market doesn’t give the Fed a greater than 50% chance of raising interest rates until the September 2015 meeting.
In an interview with CNBC on Monday, Janus Capital’s Bill Gross said in response to a “yes or no” question about whether or not the Fed would raise rates in 2015: “Close.”
And so while the focus for this month’s meeting is on the Fed’s exact language, each meeting gets us closer to the Fed’s first rate hike in years.
And that will be the real event.
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