FOMC September preview – Beware of a change in forward guidance

When the FOMC meets next week the big question is whether the forward guidance on the future path of interest rates will be confirmed or changed. To refresh your memory, the Fed has been taking two unusual actions over the last few years.   First it has engaged in quantitative easing by buying treasury and MBS bonds in the market. Second it has tried to assure the market that it was not going to raise rates any time soon. As QE winds down next month, minds are turning to the forward guidance.

Forward Guidance

Our guess is that either at this meeting or the one in December, the next two occasions with a press conference from the Chair, will be when forward guidance is adjusted. As of last June’s meeting, the members of the FOMC anticipated Fed Funds rates, currently around 0.1% to rise to around 1% by the end of 2015.   Usually, the Fed likes to move gradually so one plausible path which is consistent with the Fed’s published material, would be to raise rates by 0.15% in the middle of next year, and by 0.25% each of the next three meetings.

This scenario is inconsistent with continuing the FOMC statement which last read “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends.” What is a considerable period? Chair Yellen said about six months at her last press conference. If we put all the pieces together, they add up to the removing that language from its statement sometime soon. However, last year’s taper tantrum showed that the fixed income market can overreact to Fed intentions.

In sum, the Fed has a communications problem: to let the market know that even considerable periods of time must end while minimizing bond market gyrations. Best to stay alert for market disruption around and after the press conference, next Wednesday, September 17.

Will the fed be aggressive in raising rates?

The Fed still has the substantial policy dilemma we have covered in the past (here and here, for example). We will update here our Dual mandate Report Card showing that the Fed is still in the happy situation where there is no conflict between encouraging the labor market to improve and maintaining price stability.


There is a great deal of discussion, however, about exactly how much slack is in the labor market.   Specifically, how many of the millions of Americans who dropped out of the labor force since the financial crisis can be enticed back in? Aging population means that many workers have retired and are not seeking new jobs. Chair Yellen’s speech in Jackson Hole was not quite as dovish as I had anticipated giving more credence to the idea that a good part of the reduction in the percentage of the population working or looking for a job permanent. See this report by Stephanie Aaronson and her colleagues at the Federal Reserve for one careful study which estimates that only 1/4 to 1 percentage points of the 3 percentage point drop in the labor participation rate will be recovered.

I will agree with Cardiff Garcia (here, for example) that given the low levels of current inflation, the stability of inflation expectations, long-term under shooting of the Fed’s inflation target and a weak global growth environment, the safest thing for the fed to do would be to allow rates to remain low until they can find hard evidence of higher inflation.

 Smart reads to dig into before Wednesday:

    • Tim Duy previews the FOMC
    • SF Fed on the difference between Fed forecasts and the fed fund futures market
    • Gavyn Davies on the stability of the US recovery


– John Eckstein

[Updated September 16]
See also Gavyn Davies take. I agree that changing the “considerable” language in December makes the most sense and that is what I would vote for. I do wonder, however, if Chair Yellen will attempt to prepare the ground for next quarter’s change in this quarter’s press conference.

Yellen testimony confirms view of labor market slack

Fed Chair Janet Yellen gave her semi-annual report on monetary policy to the Senate today. Its content is consistent with our interpretations of both monetary policy and the labor market. The key phrase from our standpoint is:

“we currently anticipate that even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the federal funds rate below levels that the Committee views as normal in the longer run

We interpret this to mean a delayed and slow increase in short term rates, starting perhaps in the second quarter of 2015.

Secondary labor market indicators show improvement, slack

From time to time we also like to highlight some secondary labor market indicators to gain a deeper insight into the economy. The chart below shows both labor market improvement as well as continuing slack.


The red line shows the quit rate, the percentage of the labor force quitting each month. It is at its post-recession highs but still well below where it was in the last recession, telling us that employees are becoming somewhat more confident about finding another job but there is still concerns about the demand for labor. The green line is job openings as a percentage of the labor force, which is about as high as it was before the last recession. Logic suggests that these openings will be filled in the future. Finally, the blue line shows the percentage of the labor force which is working part time, involuntarily (people who would take a full time job if they could find one). While much improved, this measure shows substantial slack left in the labor force beyond the unemployment rate. About 2.9 million part time workers would need to be made full time for the rate to return to the 3% level we saw from 20002 to 2007.