“Low rates of resource utilisation.” That was one of the three factors the Fed has identified as preventing a rate rise for at least six months. With unemployment now at 10.2 per cent, and probably peaking nearer 10.5 per cent, “resource utilisation” is unlikely to be the trigger for an early rate increase. Indeed, if unemployment alone decided interest rate policy, we could see near-zero rates for a very long time: Fed unemployment forecasts are about 8 per cent two years from now.
The Fed’s other two conditions for the rate-holding policy are “subdued inflation trends and stable inflation expectations.” Both of these are potentially influenced by the dollar, commodity prices and asset prices.
The Fed could keep rates on hold well beyond six months if growth is subdued, inflation expectations continue and the expected further disinflation materialises – as Fed doves are sure they will, given the level of unemployment. Indeed, HSBC reckons the first hike will not come until 2012: for the record, I don’t think this is completely insane, though I wouldn’t bet on it.
Conversely the Fed could raise rates within the six months if we see some combination of dollar weakness, commodity price strength, asset price inflation and/or a surprise increase in growth changes inflation expectations. My sense is that policymakers see this as a non-trivial probability but it is absolutely not the base case.
I think the reaction function is now pretty clear. Let’s see what happens to the forecast.