The Fed Tries to Thread the Needle

Last week, the Federal Open Market Committee decided to leave the target Fed Funds rate unchanged at 0%-0.25%. This was consistent with the views expressed in the pricing of Fed Funds futures, but it was still a disappointment to those who believe that the time has come for the Fed to begin to back away from the unprecedented levels of monetary policy accommodation that it has provided to the financial markets since 2008.

In its statement, the FOMC said that it wants to see further progress in the labor market and be more confident about a move in inflation back toward its target of 2%. In her press conference following the release of the FOMC statement, Fed Chairman Janet Yellen also expressed concerns about weakness in the global economy and especially in emerging markets.

The decision to postpone is a negative signal for investors. If financial markets are still so fragile after nearly seven years of the Fed’s zero interest rate policy, why should investors put their money in equities? Is the U.S. economy really so fragile still that banks (and other borrowers) cannot afford to pay an extra $250 per year to borrow $100,000?

The decision to postpone is also risky for the Fed. New developments – a decline in the equity markets or geopolitical tensions – could surface in the months ahead, making it even harder the FOMC to make its move.

It is understandable for the Fed to be “data dependent” on key decisions. At some point, however, surely the Fed recognizes that the continuation of a policy that distorts the functioning of financial markets becomes a greater risk than subpar levels of economic activity?  Even in the face of data that is less than ideal, the Fed must eventually show leadership.

Of course, the Fed would have faced similar risks, even if it had opted to raise its Fed Funds target by a quarter point last week. Many prominent economists, businessmen and commentators had urged the Fed not to raise rates. If the financial markets had suffered as a result of such a move, the Fed would have been criticized for taking action. But the FOMC could have then responded by emphasizing its long runway toward normalization. Standing pat for months after the first move, if necessary, would have eventually calmed the financial markets.

On balance, therefore, I think that the Fed missed an opportunity to take a small but important step to signal the end of its zero interest rate policy and begin the normalization process at a time when the relative costs of such a move to the U.S. and global economies are probably as low as they are ever going to be.  By postponing its decision, the Fed is effectively trying to thread the needle, emphasizing data dependency over leadership, and running the risk that new developments may make it even tougher to begin the normalization process.  Under the circumstances, what is perhaps most surprising of all is that there was not more dissension in the vote among FOMC members.

Stephen P. Percoco
Lark Research, Inc.
P.O. Box 1543
Linden, New Jersey  07036
(908) 448-2246


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