In the face of strident calls for higher rates from a vocal minority of policymakers, the Federal Reserve once again held short-term interest rates unchanged on Wednesday.
The decision means that, having forecast four rate increases this year when they met last December, and two when they met in June, US policymakers are now likely to deliver a single move, in the final month of the year.
It represents a victory for doves, including Fed governor Lael Brainard, who have consistently argued against pre-emptive moves to quell inflation when they see little evidence of its stirring. Even if they concede a quarter-point increase by the end of the year, it will leave the Fed on track for the shallowest rate-lifting cycle in modern times.
Going into Wednesday’s meeting the stars were in some ways well-aligned for a rate increase. As Fed chair Janet Yellen said herself, policymakers are “generally pleased” with how the economy is performing, and Federal Open Market Committee members do not appear to have been particularly spooked by soft hiring numbers for August.
Ms Yellen had done some work teeing up a move in a Jackson Hole speech in late August, saying the case for an increase had strengthened and suggesting the Fed had more or less met its twin goals.
So why stand pat? The decision hinges on a desire not to stand in the way of yet more progress in the US labour market, an argument Ms Brainard championed publicly just before the Fed went into its silent period before this week’s meeting.
The rate of unemployment is 4.9 per cent, no lower than it was at the start of the year. Given the steady pace of hiring during that period, with an average 180,000 people being taken on by employers each month, it seems more people are being pulled off the sidelines and into the active labour market.
This points to a jobs market with more scope to recover further without stoking inflation. Ms Yellen herself has in the past suggested the longer-run sustainable rate of unemployment may be even lower than the Fed’s central 4.8 per cent forecast. The central bank, she explained, has found it has “a bit more running room” to let the recovery take its course without having to step in to cool things down.
There are other reasons for caution, Ms Yellen said on Wednesday. The Fed only has limited scope to loosen policy if there is a fresh downturn. As such the risks of staying on hold are dwarfed by those of tightening too hastily and inadvertently provoking an economic downturn. In addition, the neutral rate of interest — the rate associated with a stable economy — has fallen, meaning monetary policy is only modestly stimulative at present.
Not much tightening is going to be needed from here: the Fed’s forecasts imply only one quarter-point rate increase this year, two in 2017, and three in both 2018 and 2019. In the latest of a series of cuts, the median estimate of the fed funds rate in the longer run has been trimmed from 3 per cent to 2.9 per cent.
“The dots in later years offer a more dovish tilt in terms of pace and destination,” said Richard Clarida, global strategic adviser at Pimco. “This will be a very gradual lift-off.”
In the back of some Fed officials’ minds there may be one additional motive to keep policy unchanged: the political uncertainty created by the looming presidential election.
Ms Yellen repeatedly stated that politics was not discussed in her committee, adding that this will be reflected in black and white when transcripts of the Fed’s deliberations are released in five years. Nevertheless, there is ample reason for the Fed to tread carefully given the US is less than two months from one of the most fraught general elections in modern times.
So where does this leave the hawks in the Fed? Ms Yellen tried to argue that differences between officials are minor, centring on timing rather than fundamental differences of policy. But there is no doubt that she has a revolt on her hands.
Three regional Fed presidents — Loretta Mester, Esther George and Eric Rosengren — voted for an increase. This was the first time three members dissented in the same direction since September 2011, and only the fifth time in 30 years, according to a trawl of Fed records by Goldman Sachs.
Given a number of non-voting Fed policymakers are also agitating for higher rates, among them John Williams of the San Francisco Fed, it seems unlikely that the doves will be able to stave off pressure for an increase much longer.
In a surprisingly candid description, Ms Yellen said the committee had “struggled mightily” to understand each others’ points of view.
But if the Fed enters 2017 with rates just a half-point higher than they were at the kick-off of the rate-raising campaign, the ultra-cautious brigade could chalk that up as a success.
For the time being, worries of dissenters including Mr Rosengren about the financial stability and financial market excesses stoked by low rates have been pushed to one side in favour of running a hot labour market for as long as possible.
The regular rotation of Fed policymakers in 2016 will bring a slightly more dovish tinge to the committee, leaving this contingent in a stronger position to continue advocating snail’s-pace tightening.
Among the new joiners will be Charles Evans, the Chicago Fed president, as well as Neel Kashkari of the Minneapolis Fed and Robert Kaplan of Dallas, none of whom has been banging the table and demanding an aggressive rate-lifting strategy.
It looks like 2016 will end on a hawkish note at the Fed with a second rate increase. But it is the doves at the US central bank who are winning the longer-term war.