Federal Reserve (Fed) policymakers face a difficult task this week. Although it is not expected that they will raise rates again as soon as this week’s meeting, they have to communicate the Fed’s policy intentions without the benefit of a press conference by Fed Chair Janet Yellen or a new set of economic and rate forecasts from the members of the Federal Open Market Committee (FOMC). Even in typical times, Fed communications can be subject to misinterpretation from overly anxious financial market participants often causing large—and ultimately, unwarranted—swings in prices of financial assets over a short period. While not anywhere near extremes seen in 2007–09, or even in 2011, financial markets have started the year off in a fragile state, concerned about the price of oil, global growth, China, and the potential for devaluations across the emerging markets. It is against this tumultuous backdrop that the Fed has to hand down a decision.
In short, the Fed has to “talk down” its own dot plots without causing more panic in markets via “the Fed knows something we don’t know” channel. Fed Chair Yellen and the rest of the FOMC were guilty of this at the September 2015 FOMC meeting when they didn’t raise rates, citing “global financial conditions” as the main reason. During the press conference following the FOMC statement released in September 2015, Yellen sounded overly concerned about global growth, and especially China, and those concerns spooked markets. A week or so later, Fed Chair Yellen delivered a speech on the economic and policy outlook in Amherst, MA, and downplayed those concerns. Hopefully, Yellen and the FOMC have learned that lesson.
However, the Fed and the market remain far apart where the fed funds rate will end up this year [Figure 1]. As noted below, the market now sees just one more 25 basis point (0.25%) hike this year. The Fed, as of December 16, 2015, at least, still sees four 25 basis point hikes. The FOMC has only its statement this week to help close that gap. The statement the FOMC releases this week will have to continue to stress that future rate hikes are data dependent, meaning that the Fed will raise rates if it sees continued improvement in the labor market and if it is confident that inflation is moving toward the 2% target, thus the statement is likely to include the line: “However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.”