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After weeks of mixed messages, the US Federal Reserve on Wednesday gave its clearest signal yet that there is a serious possibility of an upward move in short-term interest rates in December.
The statement had an instant impact on financial markets, which have been struggling to decipher the Fed’s intentions amid conflicting messages from a range of Fed speakers. Calculations from Cornerstone Macro now put the market-implied odds of a move on December 16 at slightly better than 50 per cent.
The Fed’s new language, issued after its latest policy meeting on Wednesday, by no means makes a December move a certainty.
Divisions within the central bank over whether it should move without good evidence of accelerating inflation and wages are still very real. And the ultimate decision will depend on the contents of a cloudburst of economic indicators that starts with Thursday’s third-quarter gross domestic product figures, followed crucially by wage numbers on Friday and jobs data a week after that.
But a handful of key changes in the Fed’s messaging on Wednesday have led to a clearer picture of the discussion within the central bank.
In particular, whereas turbulence in financial markets and overseas economies exerted an outsized impact on the Fed’s deliberations in its September meeting, the US central bank in October brought the focus back to the domestic data.
In dropping language warning of risks to US growth and inflation from skittish financial markets and a sluggish global economy, the Fed eased a major barrier to an upward move in rates — even if it insisted it was still monitoring overseas developments.
Among the possible implications is that the Fed sees recent policy easing moves by the European Central Bank and the People’s Bank of China as a net positive for the US, because they will help global growth.
Further stimulus from the ECB in particular in December could well carry a nasty sting for the US by driving up the dollar, especially if the Fed is gearing up for a rise that month. Diane Swonk, chief economist at Mesirow Financial, is among those who believe the Fed needs to choose its poison.
“A strong dollar is less poisonous than a crumbling global economy. The rest of the world is stepping up where they can . . . That does give the Fed a little more wiggle room in terms of foreign risks,” she said.
Despite a run of soggy data, the Fed also decided to upgrade its language describing the strength of US consumer spending, which is far and away the biggest driver of the economy. That is a bullish statement on the health of US demand — even if it was coupled with an acknowledgment by the Fed of softer jobs numbers.
The other big shift was the Fed’s decision to explicitly name its December 15-16 meeting as a moment where it will consider the merits of a move. Fed chiefs have always insisted every meeting is “live”, but many financial market players had started to drift towards a view that the central bank was quietly starting to give up on 2015.
“They went out of their way to brace the markets,” said Robert Tipp, chief investment strategist at Prudential Fixed Income. “It was a surprise return to the active, potentially hawkish side from what seemed a pretty cautious posture in the last meeting.”
An extra plus that the Fed did not mention was this week’s deal in Congress lifting the debt ceiling and paving the way to a two-year budget agreement. That should remove the danger of a government shutdown or worse fiscal crisis in December — something that would have quickly removed any chance of a change in Fed policy that month.
Apart from a number of critical data releases, among the key events to watch from here are the minutes to Wednesday’s meeting, a speech from Janet Yellen, the Fed chair, on December 2 and testimony to Congress the following day.
December may be firmly in play, but it is very far from being a nailed-on certainty. The jobs data could yet sag further, and inflation and wages remain quiescent. Ms Yellen might be more reluctant to move if there were still a risk of outright dissent by either Lael Brainard or Daniel Tarullo, the dovish duo on the Federal Reserve Board.
But after befuddling markets with murky messaging at its September meeting, the Fed laid down a clearer marker on Wednesday. December is in the crosshairs and traders cannot claim they have not been warned.