The Fed and the Return of Ad Hockery
There has been sharp rise in US interest rates and the dollar in the immediate response to the Federal Reserve’s statement. The key it seemed was the expectation that federal funds would be at 1% at the end of next year. This is more than the market had expected. The December federal funds futures were implying a yield of a little less than 65 bp prior to the statement. This is cited for illustrative purposes as it dawns on the market what a 1% federal funds target at the end of next year implies. We note that despite the stock market decline, financials are doing well.
It is true that this is not a very actively traded futures contract, but it suffices for our purposes of illustrating the hawkish sense of the FOMC statement regardless of the other caveats they offered, like keeping rates low for longer.
The fact that the 6.5% unemployment threshold was dropped is a minor point. It had been widely tipped that the Fed would shift from the quantitative approach to forward guidance to a more qualitative approach. The buzz is that Fed policy becomes data-dependent. But when isn’t it ?
The more qualitative approach means looking at a wide range of variables, but ultimately is euphemism for ad hockery. This is the opposite of a rules-based approach. The quantitative threshold gave a rules-based appearance to the Fed’s stance. The Fed looked past the slowing during the winter and see underlying strength returning.
Kocherlakota dissented on the grounds that the statement does not bolster confidence in the Fed’s 2% inflation target.