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Analysis

Market turmoil turns Fed dovish

by Darrell Delamaide

Market turmoil turns Fed dovish

Close readers of the Federal Open Market Committee statement from the panel’s late January meeting detected a note of caution bordering on uneasiness. Federal Reserve Vice-Chair Stanley Fischer (voter) sounded the same themes in a major speech at the start of this month.

Speaking at the Council on Foreign Relations in Washington, Fischer affirmed that the slowing economy – visible in the data after the Fed raised rates in December – had prompted the FOMC to keep rates unchanged in January and plan only a very gradual trajectory of increases in the coming months.

For one thing, Fischer said, ‘Further declines in oil prices and increases in the foreign exchange value of the dollar suggested that inflation would likely remain low for somewhat longer than had been previously expected before moving back to 2%.’

Structural adjustments in China and the impact of low prices for oil and other commodities in emerging markets have engendered considerable volatility in asset markets.

‘At this point, it is difficult to judge the likely implications of this volatility,’ Fischer said. ‘If these developments lead to a persistent tightening of financial conditions, they could signal a slowing in the global economy that could affect growth and inflation in the US.’

He quickly added, however, that ‘we have seen similar periods of volatility in recent years that have left little permanent imprint on the economy’.

Fischer highlighted the Fed’s overall accommodative stance in keeping its balance sheet at historically high levels by reinvesting principal payments from its securities portfolio: ‘Doing so should help support accommodative financial conditions and so reduce the downside risks to the economic outlook in the event of a future adverse shock to the economy.’

Slack in the labour market

The vice-chair clarified that the committee would be willing to see unemployment fall below what it considers a level that might carry inflation risks.

This is because policy-makers feel there is still considerable slack in the labour market – people working part-time who would prefer full-time jobs, and those staying out of the labour market altogether but who would like to work.

In a similar vein the new head of the Dallas Fed Robert Kaplan (non-voter), who argued in favour of the rate hike in December, turned somewhat more dovish in January.

In remarks to reporters in Dallas earlier in the month, he said that FOMC participants’ median expectation of four rate hikes in 2016 was ‘not baked in the cake’.

But he added that there could be enough positive information to hike the federal funds rate by another quarter point by the committee’s second meeting in March.

Kaplan grew more cautious in interviews in late January, noting that the committee’s most recent statement had omitted the word ‘balanced’ to describe the risks facing the US economy.

‘It should be saying to people (that) we are going to take some time here to understand what is going on,’ Kaplan told Reuters.

Fumbles in China and plunging oil prices were among the concerns causing policy-makers to pause, he indicated.

‘When you put all that together, I think there is good reason to be patient (and) take more time to assess the impact on the US economy.’

A need for more information

Kaplan, who took over the Dallas Fed in September after a career that included a long period with Goldman Sachs, sounded the same tone in a separate interview with Bloomberg.

‘There is no predetermined path, we are going to be agnostic about this, we are going to be data-dependent and I need to see more information,’ he told Bloomberg on a visit to New York. ‘I wouldn’t even speculate on what the next move is.’

San Francisco Fed chief John Williams (non-voter) also changed his tune from December, when he said the four rate hikes forecast for 2016 were in line with his own expectations.

‘Standard monetary policy strategy says a little less inflation, maybe a little less growth, and argues for just a smidgen slower process of normalising rates,’ he told reporters in late January.

Dennis Lockhart (non-voter), the head of the Atlanta Fed, was openly sceptical in mid-January that the Fed panel would have enough new information to proceed with a rate hike at the March meeting.

‘How much will we know about inflation trends or inflation developments going into the mid-March meeting?’ he told reporters following a speech in Atlanta. ‘We will have some data but not a great deal more.’

Very few economists now expect the Fed to follow through with four rate increases this year and predictions – guesses – range from none to three.

Fewer go as far as Nobel economist Paul Krugman, who posted a blog just before the January meeting to the effect that the Fed had erred over the December rate hike.

Given the market volatility in January, Krugman said, ‘Surely everyone would be feeling more comfortable if the Fed had waited, and probably decided not to hike for a while.’

Darrell Delamaide is a writer and editor based in Washington, DC.

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