Ending one of the most “unusually uncertain” run ups to a policy meeting, the FederalReserve decided to wait for a better time to implement the right decision from a longer-term perspective. It did so for reasons that do not come easily to an institution that has historically been a lot more responsive to domestic rather than international issues. And it packaged its decision not to raise interest rates for the first time in almost 10 years in wording that keeps its options wide open for the coming months.
When push came to shove – and in a break with history during a non-crisis period for the global monetary system – Fed officials decided to allow international issues to play a decisive role in the determination of domestic interest rates; and they did so because of concerns about a possible two-way causality that are strong enough to offset what is a rather solid internal case for initiating now the interest rate normalisation process (particularly impressive job creation and emerging evidence that stronger wage growth is likely to put upward pressure on energy-depressed inflation rates).
First, and foremost, central bankers seem worried that a rate hike now could inadvertently fuel further financial volatility abroad, accelerating the retreat of investors from risk assets. This “quantitative tightening” would add to general financial market instability, undermining the key notion that central banks are both able and willing to repress financial volatility.
Second, and equally important, they seem worried that this would, in turn, further undermine growth – particularly in the emerging world where a generalised growth slowdown is increasing the risk of financial accidents – and thus spill back to the US. This would weaken what remains a sub-par recovery here.
The communication that accompanied today’s Fed non-action (from the official statement to the update to FOMC members’ quantitative indicator, or the “blue dots”, and the signaling at the press conference) is meant to maintain policy options wide-open regarding the timing of the first hike – from waiting for 2016 to moving as early as next month (and they have already gone through a dry run to hold a previously non-scheduled explanatory press conference).
Market reaction to all this will – almost inevitably – be all over the place.
At one level, many market participants will welcome the delay to an interest rate hike, seeing this as timely confirmation that the Fed remains their best friend, still deeply committed to a volatility-repression regime. But several will regret the general uncertainty associated with the continuing focus on – or more accurately, obsession with – the timing of a first rate hike. And some will wonder what Fed officials are signaling about the underlying fragility of global financial conditions, particularly in the emerging world.
All of which is to say that the Fed also has an important to-do list in the run up to the next FOMC meeting.
Fed officials need to work harder at gradually shifting markets’ focus, and the loud rhetoric that accompanies it, away from obsessing over the timing of the first hike to concentrating instead on the entirety of an unusually “accommodative” interest rate cycle. Indeed, as signaled by the revisions to the “blue dots,” Fed officials are now also anticipating the “loosest tightening” in the institution’s modern history: one that will be characterised by a very shallow path, stop-go sequencing and a lower end point.
After remaining silent for over two months, chair Janet Yellen took a notable step in this direction at her press conference today. This needs to be part of a more concerted and coordinated effort by the vast majority of the FOMC members.
Otherwise, the Fed risks finding itself in a cul de sac that, in itself, would risk transforming it from a volatility suppression machine to being a source of financial and economic instability.
Get alerts on Central banks when a new story is published