Fed Takes Another Step Toward Normalization

The Federal Reserve upgraded its assessment of the labor market, and changed the future guidance from “considerable time” to “can be patient in beginning to normalize the stance of monetary policy.” The statement also draws a distinction between market-based measures of inflation expectations, which have fallen, and survey-based measures, which are stable. We expect Yellen to indicate that the change in wording is not a change of intent. 

There were three dissents:  Fisher and Plosser from the hawkish side and Kocherlakota from the dovish side. Fisher is not advocating an immediate hike, as the dissents at the BOE are, but rather thinks the date of the first hike has moved up since October. Plosser also did not favor an immediate hike, but did not believe the “passage of time” should be “a key element in its forward guidance.” Kocherlakota is more concerned about the market-based measures of inflation expectations. 

The stock market extended its rally. The yield curve steepened as the long end of the curve retreated, while the short-end rallied. The dollar eased, paring some of its earlier gains.  

The Federal Reserve cut its inflation and unemployment forecasts. It see faster improvement in the labor market and slower improvement in inflation. The Fed funds forecasts were trimmed (1.125% for the end of 2015 vs 1.38%) and 2.5% for the end of 2016 (from 2.88%). Fifteen of the Federal Reserve members now see a hike in 2015 (up from 14 in September) and two see the first hike in 2016. 

Once again the Federal Reserve is looking past market volatility.  It looked past the October volatility as well. The discussion about it may be in the minutes again.

II

Many economists, including Krugman, want to talk about what the Federal Reserve ought to do. It makes for interesting op-ed pieces and wonderful discussions. However, what we are interested is not what the Fed ought to do in some normative sense but what it is likely to do.