Considerable Time

The FOMC statement this afternoon isn’t likely to pull any tricks. Given the strength in stock prices so far this week, investors might be expecting some treats. It’s likely that Fed officials were spooked by the violent selloff in stocks earlier this month. So at their pre-Halloween two-day meeting that ends today, they might decide not to surprise the markets one way or the other now that stocks have rebounded. In other words, there might not be any significant changes in the language that appeared in the previous FOMC statement on September 17. If so, then no news should be good news.

For the market, the treat would be if today’s statement still includes the following language from the previous one: “The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.”

After the release of September’s strong employment report on October 3, the odds of dropping the “considerable time” boilerplate of the past couple of years seemed to have increased, especially since QE was about to end. However, the turmoil in financial markets during the first half of the month might dissuade the committee from deleting it.

In a 10/19 WSJ interview, Boston-FRB President Eric Rosengren said:

So we’ll have to think about exactly what’s the appropriate wording and certainly the financial context that we’re in given the volatility we’ve seen in markets. We’re going to have to weigh how best to avoid further unsettling markets that seem to have unsettled themselves pretty well on their own. So we’ll have to take all those things into consideration. I can’t give you precise language because I think it’s really a committee decision.

In other words, Rosengren and many of his colleagues on the FOMC aren’t just “data dependent.” They are also “market dependent.” Of course, there’s a long tradition for this at the Fed starting with the Greenspan Put and followed by the Bernanke Put. I’ve noted that Fed Chair Janet Yellen has been the “Fairy Godmother” of the bull market since she first joined the Fed as a governor during October 2010. Stocks have usually rallied whenever she has spoken publicly about the economy and monetary policy.

The Fed has been criticized for worsening wealth and income inequality with its NZIRP (near-zero interest-rate policy) and QE policies. Ultra-easy monetary policy has done more to enrich the rich who own stocks than to help the economy. Low interest rates have certainly hurt fixed-income investors.

In his interview, Rosengren, who is in the dovish majority on the FOMC, countered:

The biggest factor that affects inequality is losing your job because if you have no income the income disparity is quite large. So being focused on getting labor markets back to where we think full employment is I think is the most tangible way that monetary policy can impact income inequality.

Then he acknowledged:

That being said, there is no doubt that asset prices are one of the mechanisms on which this is transmitted, so people that own stocks are going to do better than people that didn’t own stocks. But that’s not the only measurement, you need to look at the whole basket. The net effect is substantially weighted towards people that are borrowers not lenders, towards people that are unemployed versus people that are employed. Wealthy people are both employed and tend to lend. The people at the lower end of the distribution tend to borrow. So as a result, I think it’s very consistent with being worried about income inequality.

Fed officials undoubtedly spent some time debating whether to drop “considerable time” from the latest statement. Looking into the past, the fact is that all the major central banks have provided ultra-easy monetary policy for a considerable time ever since the financial crisis of 2008. Looking into the future, they may be forced to continue doing so for a considerable time. That includes the Fed, no matter how the FOMC statement is worded today.

In recent weeks, I’ve written about the possibility of “one and done.” In this scenario, the Fed votes to start raising the federal funds rate in mid-2015. That throws markets into turmoil, causing the FOMC to suspend further rate hikes until further notice. In this scenario, the Fed might get spooked by a true correction in the stock market more severe than this month’s quick dip. The dollar might resume soaring, sending commodity prices into a tail spin. Liquidity might dry up in the capital markets, particularly for high-yield corporate bonds. In other words, the past few weeks might have been just a warm-up act for what’s to come once the Fed starts “lift off.”

One explanation for the latest amazing relief rally in stocks is that investors are increasingly concluding that the Fed is trapped. There’s no way to exit its ultra-easing monetary policy without causing too much turmoil in global financial markets. In this scenario, the federal funds rate remains near zero for a very long time into the future. The 10-year Treasury yield remains below 3% for as far as the eye can see.

(Based on an excerpt from YRI Morning Briefing)