Janet Yellen

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The Federal Reserve held off on raising short-term interest rates during its September policy meeting because of worries that inflation could remain stuck at lower than desired levels, according to minutes released Thursday.

The Fed has two primary goals, a thriving labor market and low, stable inflation at two percent. Policy makers concluded at the meeting they were near their goal of “full employment,” but they weren’t convinced inflation is on its way back to their two percent target after undershooting it for more than three years.

Frankly, I think they are looking through rose colored glasses with regards to full employment and simply towing the line coming from Hollywood East. We have the lowest non-participation rate since 1977, and when you exclude large portions of the people from the count, full employment and unemployment rates like 5.1 percent are easy statement to make, but it doesn’t make it a fact.

The unemployment rate reached 5.1 percent in August and stayed there in September, near the Fed’s estimates of where it will settle in the long-run. Fed staffers estimated inflation wouldn’t hit the two percent goal even by the end of 2018.

Officials had signaled in mid-summer they could move in September to lift their benchmark interest-rate from near zero, where it has been since December 2008. They delayed, but have since said they still expect to act before year’s end and the Fed has two more meetings this year, one late this month and one in December.

The tone of these minutes increases the risk of a later liftoff.

The Fed’s preferred inflation measure, the Commerce Department’s personal consumption expenditures price index, has run below two percent for 40 consecutive months. Central bank officials expect inflation will be held down in coming months by the recent surge in the dollar, which is the same as an interest rate hike, and act in the same manner by depressing exports and keeping a check on an overheated economy. Declines in oil and other commodity prices have also held inflation down, but the Fed expects those effects to wane over time.

The Fed now faces an additional challenge. Jobs data released since the meeting showed private-sector hiring cooled in August and September, introducing new uncertainty about whether the economy is fundamentally down-shifting amid slow growth overseas and a strengthening dollar. A growth slowdown will make it even harder to generate the economic vitality that would typically lift inflation from it very low levels.

As Fed Chairwoman Janet Yellen emphasized in a press conference following the meeting, turbulence in financial markets and economies abroad weighed heavily on the decision to keep rates near zero. Officials worried that “recent global economic and financial developments had imparted some restraint to the economic outlook and placed further downward pressure on inflation in the near term.”

Early in the year, many officials thought the Fed would raise rates by June, but a first-quarter economic slowdown stayed their hands. This summer a number of officials pointed to September, but expectations in financial markets for a move by then declined in August, as the economic outlook shifted. Stock prices fell, the dollar rose and yields on risky bonds increased amid uncertainties about China’s economy and other emerging markets.

Some Fed officials have described the September decision as a close call. The minutes don’t suggest there was intense disagreement with the decision to hold off on raising rates.

Within the minutes we saw the following statement: “After assessing the outlook for economic activity, the labor market, and inflation and weighing the uncertainties associated with the outlook, all but one member concluded that, although the U.S. economy had strengthened and labor under-utilization had diminished, economic conditions did not warrant an increase in the target range for the federal funds rate at this meeting.” Again, I think if several Fed members lived a day on Main Street, they would have a different prospective on economic strength  and labor under-utilization.

Thirteen of seventeen Fed officials indicated in projections released after the meeting that they expect to move this year. Ms. Yellen emphasized in a speech after the meeting that she was among this group.

San Francisco Fed President John Williams, in a speech Thursday, said he anticipates a move this year. “I view the next appropriate step as gradually raising interest rates, most likely starting sometime later this year. Of course, that view is not immutable and will respond to economic developments over time.”

Central-bank officials said the growth outlook and job performance are critical in their judgment about whether inflation is firming near two percent and the time to move on rates has arrived. The Fed’s inflation forecast places great weight on slack in the economy. As growth picks up and unemployment falls, officials believe, slack diminishes and puts upward pressure on prices. A growth slowdown now, thus, could hurt their confidence about both inflation and jobs.

“Most members agreed that their confidence that inflation would move to the [Fed’s] inflation objective would increase if, as expected, economic activity continued to increase at a moderate rate and labor market conditions improved further,” the minutes said. A few also said their confidence would rise if they saw wages picking up, though that wasn’t a precondition for a rate increase.

“Other factors important in the committee’s assessment of the inflation outlook were; the expectation that the influences of lower energy and commodity prices on headline inflation would abate, as had occurred in previous episodes, and that inflation expectations would remain stable.”

Though the Fed focuses on inflation and unemployment, some officials also are worried about excesses building in the financial system. Some worried that delaying rate increases could lead to an “undesired buildup” of financial imbalances that “would be costly to unwind and that eventually could have adverse consequences for economic growth.” However, we’ve been in uncharted waters since the creation of Quantitative Easing began, and I’ll bet these are the same Fed Members who were calling for a rate hike this time last years. Aren’t we lucky we didn’t follow the path they wanted us to go down then? 


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