On Thursday, the Federal Reserve keptits benchmark interest rate pegged at 0% to 0.25%, which is where they have been since December 2008.
At first glance, it looked like nothing really changed.
But the Fed’s statement included new language that helped explain why policymakers felt it necessary to keep monetary policy so loose (emphasis ours):
The Committee continues to see the risks to the outlook for economic activity and the labour market as nearly balanced, but is monitoring developments abroad … This assessment will take into account a wide range of information, including measures of labour market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.
Later on in her press conference, Fed Chair Janet Yellen pointed directly to the economic slowdown and market volatility in China and other emerging markets as risks.
Economists quickly flagged this new language, and some also noted that it raises all sorts of wrinkles to the monetary policy calculus.
“Global developments were brought into the discussion, “Wells Fargo chief economist John Silvia writes.”These developments bring in another element of uncertainty.”
Silvia also pointed to some internal contradiction. He argues that if, indeed, the Fed is on hold due to “developments abroad,” then we probably shouldn’t expect a rate hike any time soon because those problems abroad aren’t going to be fixed any time soon. But according to the Fed’s so-called “dots,” most members of the Fed think that we see a rate hike before the year is over. As he wrote in a note to clients on Thursday (emphasis ours):
“We believe the resolution of the global picture is unlikely to provide much guidance in the short run. While it may be said that a great majority of the FOMC expect a rate increase by the end of this year, this appears inconsistent with any reasonable expectation of a resolution of the global picture. Perhaps the global issue is just a temporary reason for no action. If so, this simply adds to uncertainty given that the global situation has made a sudden appearance that these developments are difficult to quantify and unlikely to change much before the end of the year — yet a great majority expect to raise funds rate by the end of the year? Uncertainty persists.”
He’s not alone in that thinking. Other analysts have also pointed out that factoring in the global situation makes things more complicated:
“The key factor that held the Fed back today is China, or specifically, the possibility of a more abrupt slowdown in China which could then spill over to the global economy and financial markets,” said Societe Generale’s Aneta Markowska. “The Fed wants to see this question ‘resolved to some extent’ before it raises rates. Unfortunately, it is unlikely to be resolved over the next eight weeks which makes the October rate hike unlikely.”
It’s worth pointing out that when it comes to the Fed’s decisions, generally, its main concern is the US economy. Rarely do we hear much about its thoughts on what’s going on overseas except for a few mentions in the Minutes from each meeting, released three weeks after the initial statement.
But it looks like this time around, things are a tad different, as what’s happening abroad is materially affecting businesses that make up the US economy.
And US businesses are speaking up as reported by the Beige Book, the Fed’s collection of business anecdotes from across the US.
“Relative to the last FOMC meeting (in June), US data have provided no smoking gun in either direction. But new axes of uncertainty are emerging,” writes UBS strategist Themos Fiotakis.
“Market volatility and risks to growth associated with the economic slowdown in China.‘China’ was a frequent reference in the Beige Book of economic conditions prepare for the September meeting.”
And as seen in the chart to the right from UBS, the spike in the number of China references in September’s Beige Book is noting to ignore.
In sum, as economies become increasingly more integrated, it’s increasingly difficult to ignore “developments abroad.” However, its also difficult to make decisions within certain times frames when factoring in those aforementioned developments.
“Strong data on job creation in the US continue to suggest strongly that the current stance of Fed policy is too loose, but global considerations apparently are weighing on the Committee,” Credit Suisse’s Dana Saporta writes. “Indeed, the question is less ‘When will the Fed initiate normalization?’ and more ‘Will the Fed tighten this year?‘“
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