NEW YORK/SAN FRANCISCO. — The US Federal Reserve (Fed), this week faces its biggest policy decision yet under chairwoman Janet Yellen. The Fed will put its credibility on the line regardless of whether it waits or raises interest rates for the first time in nearly a decade.
In a way it is a “damned if you do, damned if you don’t” situation for the Fed despite months of fine-tuning its message, dissecting economic data and carefully building a consensus around the idea of a cautious and gradual “lift-off” from near-zero rates towards levels it considers normal.
A chorus of detractors including former US treasury secretary Lawrence Summers, argues raising rates now would be wrong given market turmoil caused by worries about China’s economic health and global growth, and the absence of inflation risks at home.
Others say the central bank’s credibility will suffer if it delays the move and prolongs investors’ guessing game about the timing of the lift-off.
The central bank, for its part, has left the door open to a modest rate rise tomorrow.
Recent comments by Fed officials suggest it will try to comfort investors with pledges that whatever it decides, it will keep nurturing the recovery.
“The Fed is anxious to get started,” said chief investment officer at Guggenheim Partners, Scott Minerd.
“If it were to move, I think it would go out of its way to say . . . there’s no rush to do anything else,” Minerd said. “If it doesn’t, it will refer to the market turmoil, and say that . . . a rate increase is inevitable.”
Restoring some clarity about the Fed’s intentions will not be easy given how wide apart economists and investors are right now.
A group of economists polled by Reuters last week bet on a move this week by a slim margin; economists at banks that deal directly with the Fed, picked December as more likely; and traders of short-term interest rate futures were giving a rate rise this week only a one-in-four chance.
Some say the Fed itself has complicated matters by effectively tearing up its long-scripted lift-off scenario when financial markets wobbled.
First, William Dudley, the influential president of the New York Fed and a permanent voter on policy, told an impromptu news briefing last month that a September rate hike had become “less compelling”.
Then two days later, Fed vice-chair Stanley Fischer qualified that, saying market volatility could pass and that it was too early to judge its significance.
Markets have since calmed somewhat, but remain on edge.
“I’m growing more sympathetic to those arguing that the Fed has now become a source of market instability, and skipping September will raise the risk of more turmoil all the way through 2016,” said global chief economist at UniCredit, Erik Nielsen.
“Only in extreme circumstances should the Fed react to markets. Anything else suggests that they have lost control.”
As recently as July, Yellen, who took over the Fed’s reins early last year, appeared to make the case for a move this month, telling a congressional hearing that waiting longer could mean the need to hike more rapidly later.
“An advantage to beginning a little bit earlier is that we might have a more gradual path,” she said.
Late last month, however, St Louis Fed president, James Bullard, an advocate of a prompt lift-off, told Reuters that while most of his colleagues might have come around to Yellen’s view, market jitters could sway them to hold off.
Yellen, Fischer and Dudley, as well as potential swing voters — San Francisco Fed president, John Williams and Dennis Lockhart of the Atlanta Fed — are likely to hold the key to this week’s vote.
None has sent any clear signals in the past weeks, which may not just reflect concerns about fragile markets, but also uncertainty about how the economy and global markets behave in the post-crisis world.
The Fed, which has kept rates at rock bottom since late 2008, first flagged its intention to raise rates in mid-2015 as long as three years ago.
But even as the world’s largest economy kept outperforming its peers, there has often been something to give policy makers pause.
Inflation has been undershooting the Fed’s forecasts for the past three years. Then a sharp economic slowdown in the first quarter muddied the outlook enough for the Fed to give up on a June lift-off.
“The debate has already been settled,” says chief US economist at HSBC Securities, Kevin Logan, who expects a rate rise in December.
“It’s later and slower.” — Reuters.