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December 15, 2014

All Eyes on The Fed This Week

By James Picerno of The Capital Speculator

The Federal Reserve’s policy statement and updated economic forecast due out on Wednesday will be closely read in the wake of last week’s volatile market action – the US stock market suffered its worst week in several years while crude oil tumbled to a five-year low. The US economy, however, continues to deliver encouraging news, based on last week’s updates. Notably, the mid-December reading of the Reuters/University of Michigan’s measure of consumer sentiment rose to its highest reading since January 2007. Meanwhile, retail sales posted a sharply higher-than-expected increase in November. We also learned from the US Labor Department that job openings inched higher in October, close to a 14-year high. The upbeat run of numbers is expected to continue this week with today’s release on industrial production and tomorrow’s report on housing starts. No wonder that analysts continue to project that the Fed will start raising interest rates next year, perhaps midway in 2015, as many economists predict.

Deciding if a mid-2015 rate hike is still reasonable will depend on what we see with the incoming macro data in the weeks and months ahead, but for now the numbers imply that the Fed is still on track to start tightening in the new year. Support for that outlook will get a boost if Wednesday’s policy statement drops the “considerable time” reference that’s prevailed in the recent past – a phrase that’s signaled that the near-zero policy rate will roll on for, well, a considerable time. But that may be set to change. As Reuters reports:
Client notes from Goldman Sachs, Citi and Bank of America/Merrill Lynch this week deal with expectations for the removal of the wording, roughly agreeing that however close the call is, it is more likely than not that the phrase will go away.
“They are going to remove it; I don’t think (Fed Chair Janet Yellen) is going to keep it in there just because of what we are seeing with the energy sector,” said Sean McCarthy, regional chief investment officer for Wells Fargo Private Bank in Scottsdale, Arizona.
“All the other data has been strong, whether you are looking at construction, at the ISM numbers, and especially the jobs data that she cares about most.”
A critical question is how (of if) the Fed deals with the combination of a wobbly global economy at a time when the US trend is holding steady if not accelerating. “The Fed could argue that improving domestic indicators at a time of softening in the global economy leaves the risks to the outlook as nearly balanced,” reasonseconomist and veteran Fed watcher Tim Duy. “They can’t both suggest that risks are weighted to the downside and pull the “considerable time” language.”
Paul Krugman thinks that a rate hike remains unlikely for the foreseeable future. “When push comes to shove they’re going to look and say: ‘It’s a pretty weak world economy out there, we don’t see any inflation, and the risk if we raise rates and it turns out we were mistaken is just so huge’,” he says.
But Krugman’s in the minority these days when it comes to anticipating the timing of the first rate hike. Economist Peter Morici speaks for many when he recommends that “rates need to go up for both economic and political reasons — the sooner the better.” He explains that “2015 is the year to get something done because in 2016 the presidential election will cloud Ms. Yellen’s judgment.”
Whatever the Fed says (or doesn’t say), don’t overlook that Yellen and company will be dispensing a new set of quarterly forecasts as well as trying to guide expectations with words. In the previous set of quarterly predictions, the bank trimmed its growth outlook for next year’s GDP to a 2.6%-to-3.0% range, down from June’s 3.0-to-3.2% estimate. Meanwhile, the Fed’s assumption for PCE inflation in 2015 was squeezed into a slightly tighter range in the September forecasts: 1.6% to 1.9%.
Forecasts are always suspect, of course – even when the Fed’s the source of the guesstimating. But in the delicate art of anticipating the central bank’s game plan for 2015, the numbers may be more revealing than the commentary that’s set to spew forth from the Fed — and the army of analysts watching from the sidelines.
About the Author - James Picerno is a veteran financial journalist since the early 1990s at Bloomberg, Dow Jones, etc. before becoming an independent writer/analyst/consultant in 2008.  James is also the author of Dynamic Asset Allocation (Bloomberg Financial, 2010) and he writes at The Capital Speculator(EconMatters author archive here)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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