Holiday pudding – rate hike with a side of dissent

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 labour 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 labour market slack is still present and that workers’ bargaining power likely remains weak,” she said in an October 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.