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For Yellen, a September Fed surprise could close confidence gap

WASHINGTON -- Market volatility is low, U.S. census data shows income gains have reached the middle class, and workers are clawing back a larger share of national income. For now, at least, no international risk stands out and inflation may even ...

U.S. Federal Reserve Chair Janet Yellen speaks during a news conference following the two-day Federal Open Market Committee (FOMC) policy meeting in Washington, DC, U.S. on March 16, 2016. REUTERS/Kevin Lamarque/File Photo
Federal Reserve Chair Janet Yellen addresses media March 16 during a news conference in Washington, D.C. The Fed is divided enough ahead of its rate meeting Tuesday and Wednesday that a nudge from Yellen, its most influential policymaker, could make the difference, and even some investors have begun to argue it is time for the central bank to stop worrying so much about what markets expect. REUTERS

WASHINGTON - Market volatility is low, U.S. census data shows income gains have reached the middle class, and workers are clawing back a larger share of national income. For now, at least, no international risk stands out and inflation may even be picking up.

If Fed Chair Janet Yellen wants to prove that policymakers are not being pulled along by investors who for years have second-guessed them, this week may offer a rare moment of calm to do so.

The Fed is divided enough ahead of its rate meeting Tuesday and Wednesday that a nudge from its most influential policymaker could make the difference, and even some investors have begun to argue it is time for the central bank to stop worrying so much about what markets expect.

"Let's get on with it already," said Michael Arone, chief investment strategist at State Street Global Advisors.

"It will cause some challenges to the market but I think that is healthy in context of a normal business cycle," Arone said. "It will increase the cost of capital, and flush out some riskier assets in the short term. But that is probably the right thing to do."

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A Reuters poll last week suggested it is a very long shot.

The poll showed the median probability of a rate rise provided by economists was about one-in-four and only 6 percent of those surveyed expected the Fed to act, with the majority expecting the Fed to wait until December.

Fed funds futures trading shows that investors are even more skeptical than that, and expect the Fed to stay put until February - more than a year after the central bank raised rates and signaled more would come this year and next.

Instead the central bank has been stuck at the 0.25 to 0.5 percent range set last December when it lifted rates for the first time in a decade.

Doubts over economy, or Yellen?

Many investors, economists, activists, and some policymakers say the economy is still not ready for higher rates.

The receding rate rise expectations may reflect such concerns about the U.S. economic recovery. They may also reflect doubts, however, about Yellen's message that the case for a rate increase is growing stronger.

Such skepticism about the Fed's plans to end policy calibrated to fight a financial crisis and recession forces officials to perform a difficult balancing act.

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The deeper investors discount the likelihood of Fed action, the greater the risk any move will trigger an overreaction with unpredictable and negative economic fallout, making policymakers more hesitant to act.

It is a cycle that may require taking a calculated risk to break, officials say.

"We are in a minuet with markets and cannot ignore how markets are pricing," Atlanta Fed president Dennis Lockhart said last week, before the Fed's blackout period for public comments.

The Fed has been caught in that dance for five years now. While at the beginning of 2011 trading in euro-dollar futures was still foreseeing a return to typical interest rates over the next few years, that view has given way to expectations that rates will remain low for a decade to come.

Those expectations have become deeply anchored and, some argue, encouraged by the Fed's reluctance to increase rates even as the economy has approached its employment and inflation targets.

Analysts who follow the Fed complain that its framework has become confusing: low unemployment and inflation close to the 2 percent target would not seem consistent with a policy rate more aligned to a recession.

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