The Federal Reserve moved almost imperceptibly today, Dec. 17, toward eventually raising interest rates in a statement that Fed watchers called surprisingly dovish. As expected, the rate-setting Federal Open Market Committee replaced its pledge to keep its key lending rate near zero for a “considerable time,” saying instead that “the committee judges it can be patient” about tightening monetary policy.
Trying to play down the importance of the change in language, the Fed stressed that “the committee sees this guidance as consistent with the previous statement.” Fed Chair Janet Yellen said in a press conference that the committee didn’t anticipate raising rates “for at least the next couple of meetings.” That would push the first rate hike to April at the earliest, although Fed watchers expect the move to come later than that.
“Yellen appears to have taken control of the FOMC and is now firmly driving policy as she sees fit,” Steve Blitz, chief economist of ITG Investment Research, wrote in a client note. “Today’s decision was decidedly dovish,” Jason Schenker, president of Prestige Economics, wrote in a statement. Stocks rallied, giving the Standard & Poor’s 500 index its biggest gain since September on a combination of the Fed news and a rebound in energy shares.
Another document released today indicated that the Fed may actually be slower to raise rates than it had previously planned. The federal funds rate has been at zero to 0.25 percent since the end of 2008. Members of the FOMC released new predictions of how high they think the funds rate will rise. The median of their new forecasts is 1.125 percent for the end of 2015, which is lower than their 1.375 percent median estimate in September. In other words, the rate setters are postponing—again—when they expect the economy to be strong enough, and inflation high enough, to justify higher rates. The median voter on the FOMC now doesn’t expect inflation to reach the Fed’s target until 2016.
In 1977, Congress amended the Federal Reserve Act to require the Fed “to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates.” Things get complicated at times like the present when the goals seem to conflict. The first goal is close to being achieved: The economy is rapidly approaching what many economists believe is “maximum employment,” which is defined as the highest employment can get before the supply of workers gets so tight that wages get bid up and inflation begins to infect the economy. But the Fed is falling short on its second goal, “stable prices,” which it formally defines as an inflation rate of 2 percent. (The Fed says that “having at least a small level of inflation makes it less likely that the economy will experience harmful deflation if economic conditions weaken.”)
The Fed published its 2 percent target for inflation in January 2012. Since then, consumer prices have risen at a compound annual rate of just 1.4 percent—a major miss. The Bureau of Labor Statistics announced on Wednesday, Dec. 17, that the annual increase in the CPI was just 1.3 percent. To be sure, that was largely the result of the big drop in gasoline prices caused by the extreme drop in crude oil. But even stripping out the volatile categories of food and energy, the increase over the past 12 months was below target at 1.7 percent. (The Fed goes by a different measure of inflation called the price index for personal consumption expenditures. It shows the same pattern. The overall number is up 1.4 percent over the past year through October and up 1.3 percent annualized since January 2012; the core number is up 1.6 percent over the past year through October and up 1.4 percent annualized since January 2012.)
While it wasn’t mentioned in the statement, international turmoil was on the minds of the Fed voters. In the press conference, Yellen said committee members are “very attentive to global developments,” while adding that members believed the drop in oil prices was a net positive for the U.S. economy.
“The Fed would like to start raising rates. Under normal circumstances, they probably would—sooner, rather than later—based on the fact that we’re at zero [the target federal funds rate is zero to 0.25 percent] and the labor market is firming,” David Rosenberg, chief economist and strategist at Gluskin Sheff & Associates, an independent wealth management firm, told me before the decision. “The problem is that these are not normal times. The Fed has never turned a blind eye to the rest of the world.”
There were three dissents from today’s rate decision. Two were by hawks who want the Fed to move faster. The other came from a dove, Minneapolis Fed President Narayana Kocherlakota, who said that the Fed’s decision “created undue downside risk to the credibility of the 2 percent inflation target,” according to the Fed’s own paraphrase.
The Fed’s statement today leaves open exactly when the central bank will start to raise rates. As I wrote before the Fed’s statement today, investors have been surprised again and again since 2008 when the Fed has kept rates low. This chart by Deutsche Bank Securities shows the pattern:
Torsten Slok, Deutsche Bank’s chief international economist, predicted in a note to clients before the Fed’s statement that rates really will rise in 2015, because the U.S. economy is gathering strength. But he admitted, “The chart … makes you humble when it comes to the timing of the first rate hike.” It sure does.