The Janet Yellen era at the Federal Reserve began with two key changes to its monetary policy statement.
First, it dropped the unemployment rate threshold from its forward guidance. Second, Fed officials now believe that rates will be higher by the end of 2015 and 2016 than they did in December last year.
The minutes reveal there was considerable concern that investors would overreact to published forecasts, which pointed to a more aggressive policy agenda than indicated in December. As it turns out, those concerns were well founded and investors took those forecasts at face value.
To make matters worse, the Fed indicated in its original statement after the March meeting that it would wait a “considerable time” after ending its asset purchasing program before raising rates.
Fed chair Janet Yellen then indicated that she defined “considerable time” as “around six months”, which made the forecasts provided by the Fed appear sensible.
Stocks and bonds tumbled after Yellen’s comments following the meeting on March 18-19; after the minutes they posted strong gains.
The forecasts were more hawkish than most expected, while the minutes were more dovish. The minutes were largely consistent with the Fed’s monetary policy statement but somewhat at odds with its forecasts – a point I acknowledged after the meeting (The Fed won’t waver from its on-track taper, March 20).
It is a confusing state of affairs and a reminder that the Fed must do a better job at communicating its thoughts to markets. Sending a confusing message has only generated market volatility.
Analysts obsess over each and every word contained in Fed statements. They probably shouldn’t, but the reality is that they do. The Fed must communicate in a fashion that recognises this.
Since the meeting, the US labour market has improved, with non-farm payrolls rising by 192,000 and payrolls in January and February revised up by 37,000. The participation rate also ticked up to its highest level since September (How the US economy weathered the storm; April 7).
Household spending growth, meanwhile, returned to more normal levels in February and is poised to rebound further in March as the effects of adverse weather diminish (New trends in store for US spending, March 31). Inflation, however, remains benign.
Improving data has only confirmed the Fed’s suspicions that the slow start to the year was a product of poor weather and not an indication that the economy had genuinely slowed.
Given weather had been used by the Fed to explain almost every undesirable development since December, it will come as a relief that the economy is developing as expected.
Fed officials were unanimous in their belief that "it was appropriate to replace the existing quantitative thresholds at this meeting". The forward guidance used by the Fed -- a central pillar being their 6.5 per cent unemployment rate threshold -- has proved to be mostly useless. In recent months, it has failed to provide any guidance at all.
"Almost all members judged that the new language should be qualitative in nature and should indicate that, in determining how long to maintain the current federal funds rate, the Committee would assess progress, both realized and expected, towards its objectives of maximum employment and 2 per cent inflation," the minutes said.
It is the right decision and it provides the Fed with greater flexibility, which is important in an environment that cannot be characterised by a single statistic. But it also highlights the increasing absurdity of forward guidance: the Fed has effectively stated that its new forward guidance is simply acknowledging the standard considerations that form each and every monetary policy decision.
Is anyone really surprised that the Fed will keep rates low while the labour market is weak and inflation is low? How is that providing any additional guidance beyond simple common sense?
The minutes will have a greater effect on markets than they will have on the Fed’s next meeting. On April 29-30, the Fed will meet again. It is all but certain to cut its asset purchases by a further $US10 billion.
As for interest rates, it's unlikely the Fed will move before 2015 -- and it won’t happen until we begin to see inflationary pressures built across the economy. Though the economy continues to recover at a reasonable pace, inflationary pressures are still some way off.