Federal Reserve Board members today pushed back on notions of an early tightening of policy accommodation. Governor Lael Brainard gave a fairly dour assessment of the economy and emphasized that the Fed is far from achieving its goals. Importantly, she did not appear particularly excited about the outlook:
The outlook will depend on the path of the virus and vaccinations. While the number of new cases is high and rising, the distribution of multiple effective vaccines is under way. Spending on in-person services is likely to return to pre-pandemic levels only as conditions around the virus improve substantially. Most forecasts predict a significant rebound in aggregate spending this year. And there is some risk to the upside if the efficient delivery of vaccines across many jurisdictions ultimately results in a globally synchronized expansion.
Indeed, she clearly differentiates between her baseline and more optimistic outcomes:
The economy is far away from our goals in terms of both employment and inflation, and even under an optimistic outlook, it will take time to achieve substantial further progress. Given my baseline outlook, I expect that the current pace of purchases will remain appropriate for quite some time.
For Brainard, even an optimistic outlook would not quickly alleviate the inequality arising from the pandemic recession and by extension would not precipitate a need to soon scale back the accommodation provided by asset purchases. Her baseline delays changes to asset purchases even longer although “quite some time” does leave some wiggle room. She adds, however, the data dependent caveat:
Of course, the outlook is highly uncertain, and forecasts are subject to revisions—a key reason why our forward guidance is outcome based and tied to realized progress on our goals.
Regarding interest rates:
The outcome-based forward guidance communicates how the policy rate will react to the evolution of inflation and employment. It makes clear that the timing of liftoff will depend on realized progress toward maximum employment and 2 percent average inflation.
And Brainard notes that the Fed intends to look through any temporary base effects this spring:
Inflation may temporarily rise to or above 2 percent on a 12-month basis in a few months when the low March and April price readings from last year fall out of the 12-month calculation, but it will be important to see sustained improvement to meet our average inflation goal.
What is “sustained improvement?” Vice Chair Richard Clarida added some clarity on that today. Via Reuters:
“We are not going to lift off until we get inflation at 2% for a year. … We are trying to tie our hands. We are saying we are not going to hike until we get to 2%,” Clarida told a conference held by the Hoover Institution.
I was reminded that Clarida identified the one year window in a speech last November but it was buried in more technical details that made it not stand out. But in the speech he says he is giving his interpretation of the new framework. Also, Clarida says in the speech “the FOMC chose a one-year memory for the inflation threshold that must be met before liftoff is considered” yet the FOMC statement just says “risen to 2 percent and is on track to moderately exceed 2 percent for some time” and doesn’t specify risen to 2 percent for a year. In today’s comments when Clarida says “we” it sounds like he is speaking for the Committee as if this decision has already been made. Then again, he shifts from “2% for a year” to just “2%.” Those are two different goals.
I might be overthinking this so that’s enough of the weeds for now. Let’s assume that the decision has been made that the Fed will not raise rates until inflation is at target for at least a year. The importance of Clarida’s comment is that it reveals that challenges to Atlanta Federal Reserve President Raphael Bostic’s projections that the Fed could conceivably hike interest rates in late 2022. Just follow the timeline. Right now, we know inflation is still weak. Although headline CPI rose by 0.4% in December, core-CPI grew an anemic 0.1%:
Brainard already said that we should ignore inflation attributable to base effects this spring effectively meaning the one year clock wouldn’t start at the earliest until May. Suppose that inflation hits 2% sustainably in May and stays there through next April. Then you are in the zone of conditions supporting a rate hike in the second half of 2022, assuming of course consistent labor market outcomes. This seems to me unlikely; Bostic’s optimistic view remains a big lift given Clarida’s position that the Fed needs inflation at 2% for a year before hiking rates.
Interestingly, Clarida adds this:
“It actually doesn’t seem lacking credibility to markets that we are going to do that.”
That tells me that Clarida thinks market participants are correctly assessing the Fed’s reaction function, at least as it pertains to rate policy. I would say that if there is a problem, it was assessing the reaction function with regards to asset purchases. The Fed has not given clear guidance on “progress toward goals,” each meeting participant has differing views on what that means, and each participant has a different willingness to opine on potential paths for asset purchases. My baseline expectation is that the asset purchase program is held in place through 2021 but that improving economic data in the summer triggers more Fed officials to speculate on the timing of tapering in 2022. If you want tapering this year, you need to see much stronger than expected data emerge this spring.
Bottom Line: With inflation low and unemployment unacceptably high, the Fed officials have little reason to signal a shift in policy. What we have seen is more speculation than signals. Real signaling will happen only when the data turn decisively more positive.