Holiday pudding – rate hike with a side of dissent: James Saft

October 28, 2015

Oct 28 (Reuters) – Now that China appears not to matter much
any more, the Federal Reserve finds itself in the awkward
position of getting ready to deliver an initial interest rate
hike in December with a side order of dissent.

The Fed on Wednesday kept interest rates steady but prepared
the way for finally taking rates higher in its last 2015
meeting.

“In determining whether it will be appropriate to raise the
target range at its next meeting, the Committee will assess
progress – both realized and expected – toward its objectives of
maximum employment and 2 percent inflation,” the Federal Open
Market Committee said in its statement accompanying the
decision.

Specifically mentioning its next meeting was taken as a
clear sign that, data developments aside, a hike is a very live
possibility. Traders buying fed fund futures, which facilitate
bets on interest rate changes, now put a 42.6 percent
probability on a December hike, up from about 33 percent on
Tuesday and just 8 percent a month ago.

Much seems to have changed in a month, both outside the Fed,
where China is rated less of a threat, and inside, where a
bust-up over hiking is threatened.

Gone is September’s caution that global developments (i.e.
China) may “restrain” activity and put “downward pressure” on
inflation. Instead, just a flat statement that the Fed is
“monitoring” developments overseas. Well, the Fed are probably
always “monitoring” global conditions.

This neatly illustrates just how poorly thought through was
September’s decision to hang the decision not to hike on the peg
of Chinese ructions. Given that the economic data coming out of
China remains both mixed and totally unreliable, not to mention
that market prices are a sham, observers are left with very
little of substance on which to judge future levels of concern.

Equities initially sold off on the news, but rallied later
in the day.

To be sure, U.S. data between now and the December meeting
could go either way. GDP figures reported tomorrow are expected
to be less than inspiring and recent durable goods numbers point
to some potential for softening.

WHEN DISCUSSION BECOMES DISSENT

All else being equal, however, Fed Chair Janet Yellen
appears to be sailing into the possibility that she and
colleagues will raise rates over the objections of one or more
FOMC voters.

While today’s dissenter, Jeffrey Lacker of the Richmond Fed,
who wanted an increase, will presumably be pleased with a hike,
Federal Reserve Board members Lael Brainard and Daniel Tarullo
have both laid out arguments for staying on hold within the last
month.

Both argued that the Phillips curve, the supposed
relationship between unemployment and inflation, no longer works
well in current conditions. That idea is still central to how
Yellen and Vice Chair Stanley Fischer view the world. Much of
the impetus for raising rates now comes from the expectation
that improvements in labor conditions will have a corresponding
effect of pushing wages, and with them prices, upward.

Brainard disagrees:

“A variety of econometric estimates would suggest that the
classic Phillips curve influence of resource utilization on
inflation is, at best, very weak at the moment. The fact that
wages have not accelerated is significant, but more so as an
indicator that labor market slack is still present and that
workers’ bargaining power likely remains weak” she said in an
Oct. 12 speech.

That’s a bit of a Copernican statement from someone at the
heart of the Fed and it remains to be seen if Yellen as pope can
take it on board or will press ahead as if it is not true.

“This is the most exciting speech I have read in forever,”
economist and Fed watcher Tim Duy of the University of Oregon
wrote just after Brainard’s speech. “Not necessarily for the
content. But for the politics.”

Those politics don’t seem to have gotten any easier to
parse. The data don’t seem to have moved decidedly in one
direction or the other, nor are they likely to in the next six
weeks. That may well argue for Yellen and Fischer temporizing at
the December meeting, pushing the decision further out without
fully engaging with the central argument Tarullo and Brainard
make. That possibility, of waiting until March or so, may
explain the comeback equities made later in the day.

Either way, the decision is problematic.

A hike with dissents sends a difficult-to-read message to
financial markets, which already may be feeling confused about
the central inputs to policy. A delay, without fuller
explanation, as opposed to a desire for more data, will do the
same.

The pressure is on for Yellen to deliver some response to
dissent when next she speaks in back-to-back appearances in the
first week of December.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft)

(Editing by James Dalgleish)

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