Waddell & Reed Market Perspective – January 2012
The Federal Reserve — always a popular target for critics — will find itself not only squarely in the crosshairs of its usual detractors in 2012 but also likely in the crossfire of politicians from both political parties with increased attention on what are always key election issues: jobs and the economy.
Combine election-year politics with lingering high unemployment and a change among the Fed’s policy-voting ranks and 2012 may be a year where Fed Chairman Ben Bernanke has plenty of leeway
— and perhaps encouragement — to offer additional stimulus if he feels it is necessary.
New voters
Under the unique structure of the Fed’s policy-setting Federal Open Market Committee (FOMC), voting rights annually rotate among the 12 regional Federal Reserve Bank presidents. Although Fed officials are quick to downplay the significance of being a so-called “voting member,” noting that all the regional Fed presidents participate in the meetings, to those outside the policy table it is significant. And, this year, because of the annual transition, it may appear to be a dramatically different Fed. One media analysis predicted 2012 will be the “Year of the Dove.”1 Historically, Fed policy “doves” are those who see monetary policy’s primary mission as growth — or in the current environment, job creation — while “hawks” see containing inflation as the top priority of monetary policy.
In 2011, the Fed chairman saw FOMC voters from both camps dissent against policy actions. Regional Fed presidents from Dallas, Minneapolis and Philadelphia — all hawks — voted against the FOMC’s August promise to hold interest rates at exceptionally low levels through at least mid-2013. The same trio also dissented the following month, opposing the FOMC’s decision to launch a new round of stimulus, known as “operation twist.” From the dove side, Chicago Fed President Charles Evans wanted the Fed to take additional steps to stimulate the economy and dissented against FOMC decisions in both November and December.
This year, the most likely source of dissent will be Richmond Fed President Jeff Lacker. Lacker has dissented a total of five times during two previous stints as a voting member and in December was already establishing the groundwork for further dissents in 2012.
“Despite large-scale efforts to provide more monetary stimulus, growth has disappointed and inflation has ratcheted upward,” Lacker told attendees of an economic outlook conference on Dec. 19. He went on to say that “monetary stimulus can at times move inflation more than employment.”
The rest of the FOMC’s 2012 voting members, including regional Fed presidents and the Fed governors based in Washington, D.C., are all extremely unlikely to dissent against Bernanke. That includes two new Fed governors nominated in December by President Barack Obama to fill vacancies on the Federal Reserve Board. Although Obama picked Republican Jerome Powell and Democrat Jeremy Stein, Fed policy votes historically do not fall along political lines and Fed governors virtually never dissent against the chairman.
As a result, Bernanke should have far more policy leeway than he had in 2011 if he decides the central bank needs to offer the economy further stimulus.
New forecasts
The January meeting will not only include a new slate of policy voters, but it will entail the Fed taking another step in providing additional policy transparency to the markets, with Fed officials offering quarterly projections of future monetary policy. FOMC members decided on the change at the panel’s Dec. 11, 2011 meeting and announced it on Jan. 3.
The FOMC’s public communications process has been in an almost constant state of evolution, going back to former Chairman Alan Greenspan’s tenure. Until 1994, the FOMC did not even publicly announce its interest rate target changes, instead leaving it to traders to guess the Fed’s action based on the central bank’s trading activities in the market. Greenspan started the move to transparency with post-meeting statements, but the FOMC has become significantly more public under Bernanke. One example: At the conclusion of Greenspan’s last meeting as Fed chairman in January 2006, the FOMC’s publicly-released policy statement was barely 100 words compared with nearly 400 words from the Bernanke Fed’s December 2011 meeting, which also included far more perspective than what was offered by any previous Fed chairs.
In addition to instituting regular press conferences — a substantial step for the historically tight-lipped central bank — Bernanke has also instituted a quarterly Summary of Economic Projections (SEP) that reveals the range of FOMC member forecasts on economic growth, unemployment and inflation. Starting in January, the SEP will also include the interest rate forecasts, which will show a range of Fed officials’ views on future rates, the likely timing of the first interest rate increase based on their individual economic projections, and their expectations for the Fed’s investment portfolio. That portfolio has grown substantially as the Fed worked first to stabilize and then boost the economy — steps that came in addition to dropping its key interest rate target to the current historic low of 0 to 0.25 percent in December 2008.
Although some Fed officials have spoken in favor of providing the public with additional information, the minutes of the Fed’s December meeting show some were concerned that the additional forecasts may prove misleading.
Some FOMC members “saw an appreciable risk that the public could mistakenly interpret participants’ projections of the target federal funds rate as signaling the committee’s intention to follow a specific policy path rather than indicating members’ conditional projections for the federal funds rate given their (individual) expectations regarding future economic developments,” the minutes said.
The minutes also indicated Fed officials are still at work on another proposal that spells out the FOMC’s longer-run goals and policy strategy. FOMC members reviewed a draft statement at the December meeting and sent it back to a subcommittee for additional work.
“Participants generally agreed that issuing such a statement could be helpful in enhancing the transparency and accountability of monetary policy and in facilitating well-informed decision making by households and businesses, and thus in enhancing the committee’s ability to promote the goals specified in its statutory mandate in the face of significant economic disturbances,” the minutes said.
Although it is not known what was in the draft that Fed officials reviewed, it appears the Fed is likely headed toward something similar to an inflation target — the benefits of which economists have debated for years — that could either act as a guide on its own or perhaps in tandem with some kind of unemployment forecast. Such a statement would be one way of aligning policy directly with the FOMC’s dual statutory mandate of price stability and maximum employment.
There is also at least some market expectation that the Fed will announce both inflation and jobs targets. A December New York Fed survey of the 21 so-called “primary dealers” that serve as the Fed’s counterparties for open market trading operations found expectations for not only an inflation target, but “most of these dealers also commented that the inflation target would also be accompanied by an explicit unemployment forecast or further guidance on the FOMC’s (unemployment) goals,” a survey analysis said.
Not all Fed policymakers like the idea. During a Jan. 5 Bloomberg radio interview St. Louis Fed President James Bullard said that he believes the Fed is “very close to having inflation targeting.” However, he stressed that the Fed “should not tie monetary policy decisions explicitly to the unemployment rate because the unemployment rate is a somewhat mysterious economic variable.” Specifically, the St. Louis Fed chief noted the situation in Europe where unemployment has not fallen below 7 percent for two decades.
Bullard’s view, however, is not unanimously held by other Fed officials. During a November interview on CNBC, the Chicago Fed’s Evans suggested the Fed commit to holding interest rates down until unemployment falls to 7 percent as long as inflation remained below 3 percent.
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2012 FOMC voting members
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Ben S. Bernanke, Federal Reserve chairman
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Janet L. Yellen, Federal Reserve vice chair
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Elizabeth A. Duke, Federal Reserve governor
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Sarah Bloom Raskin, Federal Reserve governor
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Daniel K. Tarullo, Federal Reserve governor
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William C. Dudley, New York Fed president
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Jeffrey M. Lacker, Richmond Fed president
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Dennis P. Lockhart, Atlanta Fed president
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Sandra Pianalto, Cleveland Fed president
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John C. Williams, San Francisco Fed president
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Regardless of what change, if any, the Fed might finally settle on, one important benefit would be allowing the Fed to perhaps modify its August commitment to hold rates exceptionally low through mid-2013. In addition to the three Fed officials who cast dissenting votes against that announcement, others have been critical of the Fed’s August promise because it tied policy moves to calendar dates instead of to the economy and the economic outlook. As a result, such promises can carry little weight with markets that know policy decisions will be based on current and expected economic activity. So far, the markets have indicated a rate hike is unlikely until some point in early 2014 at the soonest. Respondents to the New York Fed survey said there is a 45 percent chance the first rate increase will come in the second quarter of 2014 or later.
Same old problem
In addition to potential confusion, a perhaps bigger problem with forecasts, of course, is that they can be off target and, as a result, introduce additional uncertainty.
The Fed may already be seeing some of that as a result of the November SEP where policymakers projected December unemployment at 9 to 9.1 percent. When the November 2011 jobs report was released a few weeks later, however, unemployment had improved to 8.6 percent — or where Fed officials did not expect to find it until December 2012. Unemployment improved again in December 2011 to 8.5 percent — its lowest level since February 2009.
Some insight to the Fed’s views about the improving jobs data can be found in the Fed’s December meeting transcript. At that meeting, some Fed officials said a reduction in workforce participation that contributed to the lower unemployment number likely meant that sentiment about an improving jobs picture was “overstated.” Fed officials noted that unemployment still remained high — particularly longer-term joblessness.
The meeting transcript also indicated that Fed officials noted unemployment still remained high — particularly longer-term unemployment; and that real jobs improvement will come only gradually. The Fed views the nation’s long-term jobless rate at somewhere between 5.2 and 6 percent, which was the general range of unemployment from the mid 1990s until the financial crisis and recession drove it to nearly 10 percent.
Long-time Fed watchers know the central bank has some history with a slow economic recovery on the eve of a presidential election. Heading into the 1992 election, President George H. W. Bush felt that the Fed was not doing enough to stimulate the economy. He later blamed Fed Chairman Greenspan for costing him a second term in the White House.
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2012 FOMC meeting schedule
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Jan. 24-25
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March 13
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April 24-25
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June 19-20
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July 31
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Sept. 12
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Oct. 23-24
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Dec. 11
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Viewed against the backdrop of 20 years ago, the promise to keep rates low into 2013 could be viewed, at least in part, as a way to try to keep Fed policy from being seen as attempting to influence the election. Similarly, while the Fed hopes that the raft of new public information about interest rate views will influence interest rates paid by businesses and consumers — it could also potentially provide the Fed with a means to signal the market about additional stimulus in advance of such moves in a way that could be viewed as more organic and derived from other policymakers rather than being directed by Bernanke himself.
A close read of the December meeting minutes, in fact, might leave some with the impression that another round of stimulus may, in fact, be on the horizon.
“A number of (FOMC) members indicated that current and prospective economic conditions could well warrant additional policy accommodation, but they believed that any additional actions would be more effective if accompanied by enhanced communication about the Committee’s longer-run economic goals and policy framework,” the minutes said.
1MarketWatch, Dec. 18, 2011
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