The United States Federal Reserve confirmed its Olympian power Wednesday, defying the laws of physics by moving forward while standing still.
America's central bankers said in a statement that they would be "patient" in waiting for the right moment to raise its benchmark interest rate from zero. This was new language, suggesting the highly anticipated shift from previous guidance has begun. Not so fast. In the very next sentence, the Federal Open Market Committee said this new guidance is "consistent with its previous statement" that the benchmark interest rate will remain unchanged for a "considerable time."
This marked one of the Fed's clumsier attempts at clarity. Philadelphia Fed President Charles Plosser, who cast one of three dissenting votes, protested that the emphasis on consistency with the previous statement was out of step with evidence that shows the economy has accelerated considerably in the six weeks since policy makers last met.
Employers created 321,000 jobs in November, the most since January of 2012. Non-farm employment has increased by at least 203,000 for 10 consecutive months, making 2014 one of the strongest years for job gains on record. The unemployment rate is at 5.8 per cent compared with 6.6 per cent at the start of the year. The Fed says its decisions will be "data dependent" and that market participants should predict the future course of interest rates by reading indicators, not tea leaves. The latest policy statement suggests traders aren't the only ones addicted to guidance: the Fed's leaders can't seem to let go either.
If the Fed is serious about wanting traders to interpret economic signals on their own, it is going to have to stop nudging markets one way or another. The decision to pair "considerable time" with a "patient" suggests that the Fed believed market participants would have overinterpreted a policy statement that erased the previous guidance. Memories of the 2013 "taper tantrum" still are fresh.
Back then, the Fed caused a world of hurt in emerging markets by abruptly signalling that it planned to pare its monthly purchases of Treasury bonds and asset-backed securities. The promise of higher yields caused international investors to rush back to the comfortable confines of the U.S. bond market, forcing central banks in India and elsewhere to intervene to keep their currencies from collapsing. Its leaders surely are wary of repeating the mistake as they prepare to raise the benchmark interest rate for the first time since before the financial crisis.
Global investors appeared to find comfort in the Fed's awkward message. There were no tantrums Thursday. Asian and European stock markets rose. Most Asian currencies strengthened against the U.S. dollar, reversing significant declines experienced in recent days. Gone are fears that the Fed is poised to do anything rash. There were even bets the Fed's benchmark rate would remain unchanged until at least May or June. Why? Because when the Fed last introduced the word "patient," in January, 2004, it raised borrowing costs five months later.
This is what we know for certain: Higher interest rates are coming. "The statement was hawkish. Full stop," said Tom Porcelli, chief U.S. economist at RBC in New York.
The Fed no longer is talking about disinflation, but rather inflation. Policy makers still want to see improvement in the labour market. Ms. Yellen said specifically during her press conference that the number of part-time workers who say they want more hours is too high. She said she would be inclined to accept a lower unemployment rate than what the Fed might typically consider one that correlates with faster inflation. The reason: a little extra stimulus might lead to more full-time jobs. The Fed can do this because although inflation remains below its 2-per-cent target, Ms. Yellen made clear that policy makers consider recent price weakness to be transitory. She also told reporters that she remains convinced that faster inflation will follow stronger labour markets.
These are the signals that investors should follow. Changes in labour market indicators, prices, and inflation expectations are key to predicting the path of interest rates in the United States. The Fed still is taking a paint-by-numbers approach to communication by relying too heavily on guidance. But this era is ending. Markets should start preparing for it.
Kevin Carmichael is a senior fellow at the Centre for International Governance Innovation.
Special to The Globe and Mail