It must have felt like they were running the Central Bank of Wonderland, rather than the United States Federal Reserve.
For much of the post-crisis period, positive observations about the state of the U.S. economy by the Fed and its leaders would trigger selling on Wall Street—an upside-down reaction worthy of Lewis Carroll. Investors liked a benchmark interest rate of zero. They liked even more the tens of billions of dollars the Fed was pumping into the economy each month. Decent economic growth caused all of that to go away. So good news became bad.
But this just in: good news might be good news again.
The Fed’s latest policy statement shows the central bank remains on track to raise its benchmark interest this year, perhaps in September. The policy committee on Wednesday noted “solid” job gains. It also stated that a “range of range of labor market indicators suggests that underutilization of labor resources has diminished since early this year.” That phrase is awkward, but important. The Fed’s mandate is to achieve stable inflation and “maximum” employment. The U.S. unemployment has been at a level consistent with the later mandate for some time.
But Fed Chair Janet Yellen was unsure the jobless rate was sending a clear signal. Too many part-time workers wanted full-time hours and wages were stagnant. So Yellen expanded her dashboard. And the dials all are starting to point in the same direction. “Economic activity has been expanding moderately in recent months,” the policy committee said in its statement. That means the day the Fed begins raising interest rates is drawing closer.
What did stock markets do in reaction to this news on Wednesday afternoon? They rose. And they rose in Asia, too, with the exception of China, where investors are gripped by a sudden crisis of confidence. But the broadly positive reaction is significant because higher interest rates in the U.S. trouble some people in Asia. They worry that international capital will rush back to Wall Street when the Fed raises interest rates. But Thursday’s trading suggests those fears are subsiding.
The neutral-to-positive reaction also is a testament to Yellen’s efforts to prepare the world for higher interest rates. The Fed’s decision to reverse its policy of creating money to buy bonds caused all kinds of volatility, mostly because the communications were handled badly. The inevitable increase of the Fed funds rate is starting to look like it could be a non-event. Yellen seems to have persuaded the majority of investors that liftoff doesn’t mean borrowing costs will be headed straight up. The Fed continues to characterize growth only as “moderate.” The increase in the benchmark rate, when it comes, likely will be followed by one or more decisions to leave policy unchanged. Former Fed chair Alan Greenspan tended to move the benchmark rate systematically higher or lower in quarter-point increments. Yellen has stated specifically that she dislikes that approach. She has spent the better part of a year conditioning investors to become watchers of data rather interpreters of Fed code.
Still, old habits die hard. Tom Porcelli of RBC Capital Markets in New York directed his clients Wednesday to take a close look at the the third paragraph of the policy committee’s statement. Officials said they would raise the benchmark when they have seen “some” further improvement in the labour market. The committee had been saying that it would need to see “further improvement,” sans modifier.
“In other words, they just lowered the bar to liftoff,” Porcelli said in a note.
Actually, it is the stronger economy that lowered the bar to liftoff. Yellen just is making good on her promise to make policy on a meeting-to-meeting basis. But the point is the same: the Fed finally sees a way out of the rabbit hole.