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The “Reasonably Confident” Fed and Its Four Omens

Forget the “patience” and “considerable time”. These two words no longer describe Fed’s attitude toward increasing the near zero interest rate. Last week, Yellen and her colleagues expressed their confidence that inflation is on the way back to their 2 percent target before liftoff. In her press conference on March 18th, Yellen stated the four targets that Fed will be carefully eyeing.

1. Fed would like to see a (much) stronger labor market performance. Since this February, the unemployment rate has been around 5.5 percent. This relatively low number encouraged FOMC to lower its estimate of longer-term unemployment to 5-5.2 percent. Yellen and others at Fed expect that this continuous decline in unemployment will eventually accelerate inflation. Considering this trend, I think this may be the first sign to be realized.

2. Related to the first topic, Fed is on looking out for growth in wage as a sign for inflation. The organization is hopeful that rising employment will cause wages need to break out of their slump. Although this sounds like an acceptable line of reasoning, I believe Fed may be a bit “too optimistic” about this particular sign. As the graph below depicts, average hourly earnings grew just 2 percent over the past year through February. Put it differently, there simply is no sufficient data to back up Fed’s optimism for the wage growth.

Screen Shot 2015-03-20 at 8.05.26 PM

3. Fed also stated that it would like to see core inflation (inflation without food and energy components) stabilize or rise. With the substantial drop in global oil price, inflation rate that includes market activities in energy sector may not serve as the best indicator for the price change. Thus, Fed will be looking closely at core inflation rate. However, the graph below shows that core inflation itself has been on a falling trend. Now, I do not remember who it was, but one of you posted something about core inflation last month or so. If you are the one who wrote the post I am talking about, could you summarize what it was in the comment below?

Screen Shot 2015-03-20 at 8.29.52 PM

4. Lastly, Fed expects to see inflation itself to rise a bit.The best case scenario would be the move back to 2 percent. Given the unlikeness to observe sign #2 and #3 mentioned above, I am not so sure about the possibility of this case either.


One Comment

  1. Note that you can go to FRED to get these graphs. If you use the link available for each of there series, you can potentially have a graph that will automatically update.

    So while it removed the word “patience” the Fed is in fact not pointing to data suggesting that we don’t need patience. [Do I have my double- and triple-negatives straight?] The one proviso is that the Fed may want to raise rates prospectively. The Bank of Japan did that, too, some 10 years or so back: “things are stabilized, we don’t want to wait too long” was their reasoning. The result however was that this early BOJ frost killed the green shoots, and the economy went into reverse.

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