The Federal Reserve’s Axis of Symmetry

The Federal Reserve has two primary mandates: maximizing employment and stable prices. Congress also included moderating long-term interest rates as part of the Fed’s overall objective, but that should be the offshoot of stable prices. In May the unemployment rate fell to 3.8% which is the lowest since April 2000. If it drops to 3.7% in coming months as seems likely, it would be the lowest since October 1960. By any assessment the Fed has achieved its goal of maximizing employment. Prior to 2012 the Federal Reserve did not have an explicit inflation target. That changed on January 25, 2012 when Federal Reserve Chairman Ben Bernanke established a formal 2% target for inflation, as measured by the core Personal Consumption Expenditures price index (PCE) that excludes food and energy. The core PCE was 2.0% in January 2012, but then proceeded to decline and remained under 2.0% for most of the next six years. The failure wasn’t due to the lack of trying by the Fed as it kept interest rates near zero percent from 2008 until December 2015, and continued its QE programs until the end of 2014. The biggest drag came from the precipitous fall in oil prices from June 2014 until early 2016, which caused the All Items PCE to plunge and pulled the core PCE down as well.

In recent months the core PCE has been working its way back toward 2.0% and I expected the Fed to communicate that 2.0% was not a ceiling and would not overreact if the PCE went above 2.0% for a period of time. After the FOMC meeting on May 2 the Fed inserted the word symmetric into its post FOMC statement for the first time. “Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to run near the Committee's symmetric 2 percent objective over the medium term.” The Fed has indicated that its 2.0% target will be an axis, rather than a ceiling and will allow the core PCE to drift above 2.0% without a change in monetary policy. Should the core PCE exceed 2.0% in coming months, the Fed will continue with its pace of gradual rate increases, but will not accelerate the pace. The Fed is almost certain to increase the federal funds rate again when it meets on June 13. Although the symmetric message was expressed in the FOMC statement on May 2, the bond market didn’t clearly get the message until the minutes of the May 2 meeting were released on May 23. From the close on May 22, the yield on the 10-year Treasury bond fell from 3.065% to 2.931% on May 25, with the yield on the 30-year Treasury falling to 3.090% from 3.209%