- There's been noise that the Federal Reserve may suddenly start tightening policy or move towards raising interest rates.
- But if you look at history and the Fed's recent communications, this won't happen.
- So everyone calm down.
- Neil Dutta is head of economics at Renaissance Macro Research.
- This is an opinion column. The thoughts expressed are those of the author.
- Visit Business Insider's homepage for more stories.
With the US economy poised to come out of the COVID hit in a strong position, the economic worriers are exhuming an old boogeyman to pin their doom and gloom on: the Federal Reserve.
Despite worries that Fed officials are going to cut off their support for the economy and raise interest rates sooner to head off coming inflation (that probably isn't coming) it is too early to suggest a change in Fed policy is on the near-term horizon.
First, the bond markets can often jump the gun on Fed interest rate hikes, pricing in tightening cycles that never actually arrive. This was quite rampant following the financial crisis.
At the first sign of economic improvement, bond markets would assume the Fed was ready to move against potential inflation with decreased bond purchases and higher rates. As the Fed pushed back on the idea of less economic support, markets eventually caught on. For investors, this dynamic creates trading opportunities in the front end of the yield curve. Markets shoot first and ask questions later. The Fed tends to ask questions first.
Pay attention to those that matter
Second, the cacophony of "Fedspeak" — that is, speeches and interviews by Fed members —can often send investors in opposite directions. One way to cut through the noise is simply to focus on those speakers that are actually in charge of setting interest rate policy.
In practice, this means paying attention to the Fed's Board of Governors and ignoring the regional Fed Presidents, who vote on a rotating basis. A consensus builds at the Fed from the Board of Governors on out, not the regional Fed banks on in.
2013's "taper-tantrum" — the investor freak out over whether the Fed was going to decrease the amount of bonds it was buying and potentially raise interest rates — was sparked by comments from then-Chairman Ben Bernanke – straight from the horse's mouth. Today, the "taper-talk" so far has been fueled by a number of regional Fed Presidents. By contrast, Vice Chair Rich Clarida was pretty clear that he does not expect the Fed to pull back on its asset-buying program this year. Who should investors go with? The answer is obvious: Clarida.
Asset purchases separate from rates
Next, having gone through a cycle, the Fed has a bit more experience with its post-crisis toolkit now than it did back in 2013.
At the time, most investors assumed that the Fed's bond buying and interest rate hikes were closely linked. Thus, when Bernanke suggested slowing bond purchases in May 2013, the fixed income markets assumed an increase in policy rates was just around the corner. The two-year yield started shooting up, as an example.
But that slowing of bond buying was just that — a slowing of bond buying — and the Fed never meant to signal anything on interest rates. Eventually, the Fed and markets started to understand each other, short-term interest rates settled back down as it became clear that rate hikes were still in the distance.
Today, with the benefit of hindsight, investors understand that a tapering of asset purchases does not imply a tightening of interest rates.
The economy does not support a taper, much less higher interest rates
Finally, the strongest reason to discount taper-talk is simply that the economic data do not support it given how the Fed is talking about the economy and interest rates.
Recall the Fed's policy guidance.
On interest rates: "It will be appropriate to maintain this target range until labor market conditions have reached levels consistent with the Committee's assessments of maximum employment and inflation has risen to 2%and is on track to moderately exceed 2%for some time."
Have we hit those marks? Nowhere close.
On asset purchases: "The Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee's maximum employment and price stability goals."
Again, are we near those marks? Again, no.
Investors would be hard-pressed to find evidence of "substantial progress" towards the 2% steady inflation goal. While, market based measures of inflation expectations have picked up, actual underlying consumer price inflation has been quite sluggish. There is still a long way to go on the inflation front.
Yes, there are reasons for optimism for the US economic outlook. The Fed's goal today is to reinforce that optimism by maintaining accommodation. This means that it is too soon to entertain talk of paring back the Fed's large scale asset buys.