FOMC Meeting: Why they didn't raise rates
Economics in a nutshell: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”
In a Nutshell: "Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term."
Rate Decision: Fed funds rate maintained at a range between 0% and 0.25%
The Fed decided that all economic and financial issues in the world are its concern and given the uncertain global economic and financial conditions, the start of rate normalization would have to wait. Boy, what a difference seven weeks make. After the July FOMC meeting, conditions seemed to be in place for a September rate hike. Indeed, fifteen of seventeen participants indicated they expected rates to be increased this year. That number dropped to thirteen and one member even thinks rates will not be increased until 2017.
So, what changed? First, oil and other commodity prices fell. There was a concern that the labor market needed further improvement, though the rate is near the members' long run rate of 4.9%. Fed Chair Yellen explained that there is some extra slack in the market because of the falling participation rate and the elevated level of part-time workers who want full-time jobs.
But the real shift was the central position of foreign issues. The recent instability in China, the rise in the dollar and the weakness in countries dependent on commodities for growth (e.g., Canada) caused the FOMC to rethink its timing of a rate hike. Adding these worries to the energy declines and supposedly labor market slack. The members' lowered their inflation outlook for the next couple of years. And since inflation remains well below the Fed's target, The Committee decided not to go for it on fourth and one, but instead punted.
So, when will the Fed start raising rates? While Chair Yellen said that October is a live meeting, it is unlikely the FOMC will get enough compelling information about China and the financial markets over the next six weeks to make an October hike possible. Indeed, we don't even know what will constitute enough knowledge of what is happening in China, especially since the Chinese data are questionable, at best, and their policies are hardly transparent.
The Fed, by making China, the dollar and the world financial markets central to its decision process, has muddied the waters. Indeed, investors seem as confused as most economists. On the news, the Dow quickly dropped about 80 points, but then rallied sharply, rising over 200 points. However, once Yellen started explaining things, the index fell over 200 points.
The Fed will eventually start raising rates, but it is no longer clear what benchmarks will have to be met before that decision is made. It could be December, but it could be sometime in 2016 as well. Right now, I don't think anyone, including Janet Yellen, has any idea.
(The next FOMC meeting is October 27-28, 2015.)
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