The Federal Reserve is probably definitely maybe going to raise interest rates in December.
And it wants the market to know that.
On Wednesday, the Minutes from the October FOMC meeting indicated that the Fed had a long, drawn-out debate about what to do — and how to do it — about telling the market it’s probably going to raise rates in December.
Here’s the relevant passage from Wednesday’s release:
In its post-meeting statement, rather than framing its near-term policy path in terms of how long to maintain the current target range, the Committee decided to indicate that, in determining whether it would be appropriate to raise the target range at its next meeting, it would assess both realised and expected progress toward its objectives of maximum employment and 2 per cent inflation.
Members emphasised that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting, provided that unanticipated shocks do not adversely affect the economic outlook and that incoming data support the expectation that labour market conditions will continue to improve and that inflation will return to the Committee’s 2 per cent objective over the medium term. Members saw the updated language as leaving policy options open for the next meeting.
And so instead of getting the markets into a “patient” versus “considerable time“-type debate that pre-occupied markets in the last few months, the Fed wanted to get markets more focused on the future.
Or rather, next month’s meeting.
Working against the Fed, of course, is that they have had policy on an emergency setting for about 7 years, and so markets are going to believe higher interest rates from the Fed when they see them.
And as you’d expect, not all Fed members agreed with these hints anyway:
However, a couple of members expressed concern that this wording change could be misinterpreted as signalling too strongly the expectation that the target range for the federal funds rate would be increased at the Committee’s next meeting. While members differed in their assessment of the likelihood that incoming information will warrant an increase in the target range for the federal funds rate when the Committee meets in December, they agreed that, in making the decision, the Committee will evaluate progress toward its objectives, taking 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.
So, the Fed needs the pump primed but also doesn’t need to be stuck in a corner.
In its October statement, the Fed got markets thinking that a December rate hike was a possibility by ultimately including the sentence, “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress–both realised and expected–toward its objectives of maximum employment and 2 per cent inflation.”
This was the Fed’s middle ground.
Markets saw this as a “hawkish” bent from the Fed, suggesting they were more willing to raise rates at the next meeting than at any point yet. This sent market pricing of a Fed rate hike up to about 50%.
A better-than-expected October jobs report that followed on November 6 sent market pricing up to about 70%. On Wednesday, the chances of a December rate hike were near 68%.
And so on balance, the market is more or less where the Fed wants — and perhaps needs — it to be. (Or as DoubleLine’s Jeffrey Gundlach said, the market and the Fed are right on the “knife’s edge.”)
But how the Fed got there was quite an internal battle and one that even when the Fed does raise rates won’t be going away because as many officials have said time and again, it isn’t about the first rate hike but about the full path.
From Wednesday’s Minutes:
It was noted that the expected path of the federal funds rate, rather than the exact timing of the initial increase, was most important in influencing financial conditions and thus in affecting the outlook for the economy and inflation. The Committee reiterated its expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.
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