The Federal Reserve signaled on Wednesday that the FOMC was going to continue with its cautious stance. This was in contrast to the general consensus of market participants that the Fed was likely to start tightening monetary policy sooner rather than later given the recent positive US economic news. Consensus had been for June 2015 rate hike, with some believing a rate hike could come as soon as March. Thus, when the FOMC indicated on Wednesday that it was likely to refrain from a rate hike as soon as consensus thought, we had the jump in markets one would expect from a surprise. The question is, were the markets right to be surprised?
Our belief has been that the Fed should remain cautious on raising rates beyond the consensus June estimate. While we have finally been getting decent growth data and job creation, there are no signs that the economy is overheating. The Fed’s preferred measure of inflation, the PCE index (Personal Consumption Expenditure), has remained below the target inflation rate. This less than desired inflation rate as measured by PCE is backed up by core CPI numbers and the Billion Price Project (BPP). While the BPP is not an officially watched measure it is interesting to see how well it tracks PCE.
Until Wednesday, ours was not a dominant view of market participants, although we are unsure why as Janet Yellen, Fed Chair, is considered a dove. Furthermore, the make-up of the FOMC is changing for 2015 and the voting membership is getting more dovish. Richard Fisher of the Dallas Fed and Charles Plosser of the Philadelphia Fed will no longer be members of the FOMC, and they are two very strong hawks. Their replacements are much more dovish, thus the overall make-up of the FOMC will be more dovish in 2015. Note that a “dove” in this context is someone who has a more cautious economic/financial outlook and therefore would prefer further monetary accommodation whereas a “hawk” is more bullish on the growth/inflation outlook and therefore is worried about excessive monetary accommodation.
Next week is a short week, but there are six potential market moving reports due: Existing Home Sales, Durable Goods Orders, GDP, Personal Income and Outlays, New Home Sales, and Jobless Claims.