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Investors spent last week parsing two significant communications from the Fed: the minutes from the July 29-30 FOMC meeting and Fed Chair Janet Yellen’s long-awaited speech in Jackson Hole, Wyoming. But instead of gaining clarity about the direction of US monetary policy, investors’ view of the future became a bit more murky.
For starters, Wednesday’s FOMC minutes showed that the Fed is increasingly divided about when rate hikes should begin. While Fed members generally agreed at their July meeting that labor conditions are improving and inflation is rising modestly, they differed about the amount of slack in the labor market. And despite growing investor anticipation that rate hikes will happen sooner, Fed members spent significant time at their meeting talking about the mechanics of raising rates—a critical prerequisite to the major change ahead in the direction of monetary policy.
“Yellen believes the Fed has a limited ability to understand changes in the labor market, making the task of determining when to raise rates all the more difficult.”
The market’s next chance for clarity came during the Kansas City Fed’s annual conference in Jackson Hole. Investors hoped Yellen’s Friday speech would crystallize the Fed’s view on labor-market conditions. Instead, many were disappointed by her equivocation about employment. While Yellen recognized that the jobs situation is getting better, she also underscored flaws in the recovery. In addition, she expressed her belief that the Fed has a limited ability to understand changes in the labor market, making the task of determining when to raise rates all the more difficult.
New 19-Factor Index Gaining Influence
Interestingly, however, Yellen's speech referenced a lesser-known gauge of the employment situation: the Labor Market Conditions Index, a dynamic model recently created by the Fed to help measure job-market conditions.
The Index is made up of 19 different factors, including indicators of unemployment, underemployment, workweeks, wages, vacancies, hirings and quits, and consumer and business sentiment. This index, which was the topic of a Fed research note in May, appears to be gaining influence with the FOMC.
This makes sense given that the 19 labor-market conditions provide a more holistic and nuanced picture of the labor market than just the unemployment rate—which was essentially dispensed with by the Fed earlier this year as a soft trigger for the raising of the Fed funds rate. It also leaves most Fed watchers with the view that Yellen remains dovish, given the Fed’s emphasis on using a wide range of information to measure the level of improvement in the labor market.
No Decision Yet
The reality, however, is that the FOMC has not yet decided when to raise rates, and there are a few factors at work here:
- First, the Fed is unlikely to embark on a course of rate hikes until after it has full confidence in the tactics and the tools it will use to raise rates and control liquidity in the banking system. We don’t yet know when that will be.
- Second, as the lead financial supervisor, the Fed must become certain that the preponderance of banks and non-bank financial institutions can thrive in a rising interest-rate environment without negative unintended consequences. The Fed does not yet have that certainty.
- Third, today’s FOMC voting membership will be different than 2015’s, bringing a slightly more dovish tilt to the group.
But there are some certainties even as the Fed walks slowly to the starting line. We know the Fed will continue to be guided more by data than by dates as it carries out its dual mandate. We know, therefore, that the Fed will not dial down monetary support until it is confident that the economy is on solid footing and inflation has become anchored at, or slightly above, the 2% target rate. And, of course, while we don’t know exactly when, we can be sure that the Fed will hike rates only after it has communicated well in advance its intention to do so. It is these certainties that should guide investors.
Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
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