We had a number of Fed speakers last week, most of them giving their version of the State of the Union.  In a nutshell, people are generally sticking to their forecasts, with some new downside risk.  Here is the relevant summary:

  • Lockhart (Monday) said that he is “optimistic about the economy’s prospects in the new year, but I will be watching the data trends closely.” He also wanted to “emphasize that the Fed’s monetary policy is still quite accommodative even with the first rate increase last month and the assumption of subsequent increases in 2016.”
  • Rosengren (Wednesday) emphasized downside risk, but called last month’s projections as a “reasonable estimate.”
  • Kaplan (Wednesday) was out saying stock market swings may not reflect the underlying economy, and officials shouldn’t overreact, and is still biased towards normalization. Kaplan (Friday) wanted to see how the market volatility affects the economy.
  • Bullard (Thursday) is claiming the strong U.S. employment would argue that the FOMC’S median projection of rate increases totaling 1 percentage point this year is “about right,” but that the drop in oil is “becoming worrisome” for 2% inflation.
  • Dudley (Friday) said interest rates will continue a gradual climb, and the outlook has not changed significantly since the last Federal Reserve policy meeting. He (the dove) is in the 2-3 hike camp, as he said 1 was too low and 4 too high.
  • Williams (Friday) was out saying the market turmoil does not fundamentally alter outlook on US economy

The most important comment is Dudley’s.  The dove did not seem particularly phased, although he probably sees some downside risk.  The Fed is “data dependent,” and they are economists.  In terms of the data, we haven’t had a noticeable change.  I realize the data has a 1 month or so lag, but it’s not clear to me that any of the past two weeks of activity will pass through to the economic data.

I suppose the Fed is not going to come out and say, “Oops.  We f*ed up,” after hiking last month.   But I don’t know that they have.  What we have is a market reaction to having the punch bowl taken away.  Didn’t we all agree last year that QE was causing excessive valuations for equities and credit?  Accommodation also played a role in the easy financing of the oil industry, which led to oversupply and the eventual collapse of oil prices.   There is going to be an adjustment to rate normalization.  It’s a little surprising that so much would be made of unwinds of conditions caused by the easy-money policies of the Fed.

This brings up an interesting dilemma for the Fed if the economy shows more weakness.  What recourse do they have?  The obvious one is to take back the 25bps they just hiked.  But what’s next?

  • Maybe another 10% drop in equities will cause talk of renewed QE.  I’m not so sure more QE will accomplish anything, other than the artificial inflation of assets.  When tens are at 2%, is driving them to 1.50% really going to achieve anything?  Is there any investment for which those extra basis points are going to matter?  But more importantly, if you know that the cure is only temporary and the withdrawal symptoms are going to be great, is it even worth it?  What’s the point of giving a heroin addict more heroin to recover from their withdrawal symptoms?
  • Negative rates. Fischer discussed monetary policy on the zero bound on Tuesday, and he seemed cautious on using negative rates.  I suppose when people feel desperate, they may be more likely to act, but I’m not so sure this is going to be that attractive.

So there aren’t many good options on the table… maybe *this* is more concerning than anything else.  It’ll be interesting to see which of the two the Fed starts leaning towards (assuming they had to choose just one).