The Conundrum Facing Janet Yellen & the Fed

The final 2014 meeting of the Fed Open Market Committee concluded yesterday, and the official policy statement released afterward contained some new language that surprised most Fed watchers. Throughout this year, the Fed’s policy statements have included an assurance that the central bank would not raise short-term interest rates for a “considerable time” after QE purchases were ended, which happened at the end of October.

Ahead of the latest meeting, a lot of Fed watchers expected the FOMC to remove the ‘considerable time’ language as it supposedly prepares to raise interest rates sometime next year. Instead, the Committee decided to throw a curve ball as follows (emphasis mine):

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October…

Being “patient” is not a characterization most would expect from the normally stoic FOMC. Chair Yellen and other members of the Committee obviously knew that the markets would not be satisfied with something so vague as ‘patient,’ so they felt compelled to add the second sentence in the quotation above, just to clarify their intent.

In plain-speak, be patient simply means the Committee has no intention of raising the Fed Funds rate anytime soon. Many Fed watchers now assumed that the ‘be patient’ language means that the Fed may not raise interest rates around the middle of next year, as has been widely expected. As a result, stocks rallied strongly late yesterday. As this is written, the Dow is up over 400 points today, its strongest performance of the year.

blog141218aBack in March at Yellen’s maiden press conference, she suggested that the first rate hike might occur about “six months” after QE purchases ended. With QE having stopped at the end of October, six months out would be in April. But it now seems clear that the Committee is not planning a rate hike at that time.

It is widely agreed that Yellen regrets having offered such a specific scenario. By adopting the ‘be patient’ language, she now feels that the Committee has more time to consider when to make the first rate hike. Yellen emphasized again yesterday that the timing of the first rate hike will be entirely dependent on upcoming economic data. But she did offer one tidbit of specificity:

[While the Fed is] unlikely to begin [the] normalization process for at least the
next couple of meetings, the timing of the initial rise in the Fed Funds target as
well as the path for the target thereafter are contingent on economic conditions.

The next FOMC meeting is on January 29-30 and the second 2015 Committee meeting is on March 19-20. So, according to Yellen, there will not be a rate hike until sometime after March and probably well after. Most Fed watchers now believe that any rate hike will not occur until sometime in the second half of next year, if at all.

blog141218bThere is another issue that the Committee members must be worried about: falling inflation thanks to plunging energy prices. As this is written, the WTI crude prices is below $55 per barrel. The Consumer Price Index fell by 0.3% in November, the largest drop in six years. For the 12 months ended in November, the CPI increased only 1.3%, well below the Fed’s target of 2%.

This is another reason I don’t believe the Fed will raise interest rates anytime soon. And they may not raise rates at all if they fear that plunging oil prices could lead to deflation setting in next year.

The bottom line is that Yellen & Company simply do not know what they will do next or when. There is just too much uncertainty going on right now to make a decision.

For those interested in what Ms. Yellen had to say in her press conference yesterday, the following MarketWatch piece has a nice summary:

Read the MarketWatch story on Chair Yellen’s press conference.

Turning to a different subject, President Obama’s “temper tantrum” continues with his unilateral action to normalize relations with Cuba. The man is simply out of control. I suggest that you read the following editorial from Senator Marco Rubio, himself of Cuban descent:

Read Sen. Marco Rubio’s editorial in The Wall Street Journal.

Let me close by wishing you and yours a very MERRY CHRISTMAS or whatever holiday you may be celebrating. Thank you for reading me this year! As always, I welcome your comments and suggestions.

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