Which way will the Fed go? Policy makers in their own words
May 3, 2016
The Federal Reserve, once well-known for being opaque and nuanced in its pronouncements, has recently become much more open about communicating policy direction. Now that it is clearer how the Fed intends to act, the question on everyone’s mind has changed to: When will it act?
This shift toward a transparent Fed has complicated the relationships between policy makers and the markets they oversee. For instance, the statements released after each Fed meeting are met with more scrutiny than ever before as investors search for clues to the possible timing of future policy actions. The back-and-forth between the Fed
and the markets has created a source of uncertainty and potential volatility that we believe will probably remain in place for most of 2016.
What’s at stake?
The Fed’s monetary policy decisions can have a direct bearing on short-term interest rates, and perhaps influence longer-term rates as well. This in turn can influence prices on fixed income instruments, including Treasurys and those further out on the risk-reward spectrum such as corporate bonds. Therefore, an awareness of central bank communications helps investors not only react to rate movements, but also anticipate future changes in the rate environment.
In search of context
For quite some time now, Fed officials have indicated that decisions on further interest rate hikes will not be based on any single formula or mechanical exercise. Instead, future decisions will be determined by the voting members’ judgments on variables that include employment, economic growth, and inflation.
A review of public comments made by members of the Fed’s policy-setting committee, the Federal Open Market Committee (FOMC), can provide a window into the committee’s collective notions about how the economy is evolving. This in turn can help us better estimate how policy decisions will be formed in the coming months. This analysis (see table below) reveals general indications about each committee member’s tendencies.
Specifically, it shows whether each member tends toward a so-called “hawkish” bias (which generally seeks tighter monetary policy in order to keep inflation in check), or a so-called “dovish” bias (which generally seeks looser monetary policy in order to foster growth and inflation).
In their own words
| Voting member
|| General sentiment: Hawkish or dovish?
|Janet Yellen (dovish)
As chair of the FOMC as well as the Fed’s board of governors, Yellen’s votes are arguably the most important across the committee. Her statements as of late have been dovish, indicating:
In addition, she has acknowledged the possibility of rates remaining below target and the likelihood of policy remaining accommodative even after target levels of employment and inflation are reached.
- a wish to see further progress in reducing unemployment
- a concern that inflation is well below the FOMC's stated target
- an intention for the FOMC to “proceed cautiously” in hiking rates.
|Stanley Fischer (neutral)
As vice chair of the Fed’s board of governors, Fischer is another important voter and has generally issued neutral indications of his leanings. In a November speech titled, “The Transmission of Exchange Rate Changes to Output and Inflation,” Fischer reminded us that “it may be appropriate to [eventually] raise the target range for the federal funds rate…though the outcome will depend on the Committee’s assessment of the progress — realized and expected — that has been made toward meeting our goals of maximum employment and price stability.” Also, in a February speech titled “Recent Monetary Policy,” Fischer reiterated that decisions to adjust policy will be “data dependent.”
|William Dudley (dovish)
As president of the Federal Reserve Bank of New York and vice chair of the FOMC, Dudley is another high-profile voter. Historically, his statements have tended to lean dovish. Speaking in April, for instance, he said: “I still judge the balance of risks to my inflation and growth outlooks to be tilted to the downside…[thus] I judge that a cautious and gradual approach to policy normalization is appropriate….”
|Lael Brainard (dovish)
Brainard showed her dovish bias at the March FOMC meeting when she cautioned about the prevalence of downside risks to economic growth: She went on to say:
“We should not take the strength in the U.S. labor market and consumption for granted….Given weak and decelerating foreign demand, it is critical to carefully protect and preserve the progress we have made here at home through prudent adjustments to the policy path. Tighter financial conditions and softer inflation expectations may pose risks to the downside for inflation and domestic activity. From a risk-management perspective, this argues for patience as the outlook becomes clearer.”
|Daniel Tarullo (dovish)
Tarullo showed a strong dovish bias in an interview in late 2015, in which he said he would be disinclined to raise rates until he saw real evidence of inflation reaching 2%. As he put it, “It’s been some years now since inflation has approached the FOMC's target. And that’s why my perspective [is] that one should watch [for] some tangible evidence…that inflation will return to target.”
|Eric Rosengren (dovish)
Rosengren historically has been dovish, as exemplified in a February speech in which he stated, “A more gradual monetary policy path is an appropriate response to headwinds from abroad that slow exports and financial volatility that raises the cost of funds to many firms.” He added, “If inflation is slower to return to target, monetary policy normalization should be unhurried.” Rosengren is president of the Federal Reserve Bank of Boston.
|Jerome Powell (neutral)
Powell does not often make policy speeches, focusing instead on the infrastructure of financial markets, especially the U.S. Treasury market. He tends to view low levels of inflation as transitory, and expects the 2% inflation target to be met over the medium term.
He has gone on the record as saying that “these low current readings are partly a consequence of two transient shocks: the dramatic decline in oil prices and the effect of the appreciation of the dollar on import prices. When the effects of these shocks pass, I expect…inflation…to rise gradually to our 2% objective over the medium term.”
|James Bullard (hawkish)
Bullard, who heads the Federal Reserve Bank of St. Louis, has been an early advocate of hiking rates. Talking to The Wall Street Journal early in 2015, he cautioned that “we would be behind the curve” if rates were not bumped up by September. He is generally against locking the Fed into a slow and gradual approach to raising rates, preferring to be more reactive and flexible.
This past March, Bullard sounded hawkish again when remarking that “the relatively minor downgrades…suggest that the next rate increase may not be far off provided that the economy evolves as expected.”
|Loretta Mester (hawkish)
As president of the Federal Reserve Bank of Cleveland, Mester has shown herself to be an early and consistent advocate of hiking rates. In August 2015, she told The Wall Street Journal that “the U.S. economy is solid and it [can] support an increase in interest rates.” Her position was unchanged in December, when she again proclaimed that the economy was strong enough to handle an increase in rates.
In April 2016, Mester continued sounding hawkish, asserting that “forestalling rate increases for too long…may simply produce more volatility in the future if we find ourselves having to increase rates more aggressively than anticipated.”
|Esther George (hawkish)
George, president of the Federal Reserve Bank of Kansas City, telegraphed her hawkishness in 2013 by dissenting from seven FOMC decisions to maintain loose monetary policy. Since then, her remarks have generally continued to embody a hawkish tone, arguing that the U.S. economy is prepared to accommodate tighter monetary policy.
At the FOMC’s March 2016 meeting, she persisted in her hawkish bias by arguing for a 25-basis-point increase in the federal funds rate, and casting her eighth dissenting vote against fellow committee members who voted to keep the federal funds rate unchanged.
All together now: A case for moving slowly on rate hikes
This member-by-member inventory of the doves and hawks within the Federal Reserve’s rate-setting committee lets us frame some generalities that we think could shape the committee’s sentiment in the near term. For starters, we believe it will make sense to focus on Janet Yellen and William Dudley, who are dovish, and Stanley Fischer, who is neutral. As they are the three most important voters, we think it’s reasonable to expect their influence within the committee to play a big part in arriving at rate-setting decisions. In short, their convictions about the still-delicate state of the economy will contribute to the committee’s adherence to an overall dovish stance (though we believe it will be slightly less dovish than it was in 2015).
In light of these findings, we believe it’s reasonable to expect the Fed to go slowly when raising rates, perhaps moving by 0.25 percentage points once or twice during the balance of 2016.
The views expressed represent the Manager's assessment of the market environment as of May 2016 and should not be considered a recommendation to buy, hold, or sell any security, and should not be relied on as research or investment advice. Views are subject to change without notice and may not reflect the Manager's views.
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