The year ahead looks to be one of change for U.S. monetary policy, and change is often painful. Memories of the “taper tantrum” of 2013, when former Fed Chairman Ben Bernanke’s hints of a scale-down of large-scale asset purchases caused sharp spikes in bond yields and mortgage interest rates, remain fresh on the minds of Federal Reserve policymakers. More recent episodes of market volatility provoked by hiccups in Fed communication about the timing of initial federal funds rate hikes provided fresh reminders.
So the Fed’s rate-setting Federal Open Market Committee can be expected to proceed cautiously—too cautiously for some.
After six years at zero, the FOMC will surely start raising the funds rate sometime this year, unless some sizable negative shock intervenes to further delay “lift-off.”
There are adverse headwinds from abroad, which the FOMC is watching. Economic weakness in Europe and Japan, slowing in China and elsewhere, together with disinflation and dollar appreciation are being eyed warily. So far those forces are not believed to be blowing so strongly as to cancel plans for policy “normalization,” but to the extent they persist they could affect the timing and pace of rate hikes.
The exact lift-off date is, of course, data-dependent, but market expectations of mid-2015 still seem a good bet. As long ago as October 2012, the FOMC was saying a near zero funds rate was “likely to be warranted at least through mid-2015.” Even though the FOMC gave up calendar-based “forward guidance” in favor of numerical thresholds in December of that year, then moved to more state-contingent language in March of 2014, the FOMC has never disavowed that time frame.
At the time of that communications shift, a newly installed Fed Chair Janet Yellen indirectly pointed to mid-2015 by saying rate hikes would likely begin “around six months” after the end of the third round of quantitative easing. Well, the last asset purchases settled in November after the FOMC made its final $15 billion “taper” on Oct. 29.
More recently, New York Federal Reserve Bank President William Dudley and San Francisco Fed President John Williams called mid-2015 expectations “reasonable.”
While markets are heavily focused on the lift-off date, the larger issue is the pace of rate hikes after they begin. In all likelihood they will be incremental. Patience, caution and a desire for confidence are ever on the lips of Fed officials.
The FOMC has said the funds rate will be kept “below normal” even after employment and inflation have reached “mandate-consistent levels,” and participants’ projections of “appropriate” monetary policy have the funds rate not getting back to its “longer run” level of 3.75% until late 2017.
Atlanta Fed President Dennis Lockhart, a 2015 FOMC voter, says it should not be assumed rate hikes will come at every meeting. Obviously, the rate trajectory pace will depend on the economic growth pace and how it is affected by those increasingly chilly headwinds from abroad.
Williams, another 2015 voter, told me in December that if adverse external factors were to intensify and dim U.S. job and inflation prospects “that would argue for more monetary accommodation, which would mean a somewhat later lift-off and more importantly a more gradual pace of raising rates.”