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11 February 2014

At the US Federal Reserve, when is a threshold not a threshold? When it’s an embarrassment

The Federal Open Market Committee is keen to hold fund rates in spite of falling unemployment. It's the first act of a newer, stricter committee.

By nick beecroft

Let’s take the Fed first. When is a threshold not a threshold? Answer: when it becomes an embarrassment.

With the unemployment rate plummeting towards the 6.5 per cent “threshold” touted by the Fed as the point at which it would consider rate increases, we were told in the statement released after their December meeting that the FOMC “now anticipates that the funds rate will be held unchanged until ‘well past’ the time that the unemployment rate has fallen below its 6.5 per cent threshold”.

This was a meeting at which a majority in favour of just lowering the threshold to 6.0 per cent, or even 5.5 per cent, obviously couldn’t be found. Thank goodness. This is certainly a testament to the sagacity of the committee, as moving the goal posts so soon after they were inserted into the ground would have been seriously detrimental to the Fed’s credibility. What’s to say the threshold wouldn’t suddenly become 5 per cent, or even be abandoned completely when it was subsequently convenient?

We should bear in mind that in many ways this was the outgoing, dovish Fed’s final act, with Helicopter Ben at the helm (or the cyclic, I guess). The FOMC composition became distinctly more hawkish at the January meeting. No surprise then that the January meeting saw another $10bn reduction in QE and no lowering of thresholds.

My guess would be that by the March meeting several clouds that have been obscuring the health of the US economy, and hammering risk assets, will have blown over. I don’t feel that by any means all emerging markets will have escaped the cosh, but I do feel that we will have avoided widespread contagion, a la the 1997/8 Asian/Russian Crises, and that the pressure will be seen as contained and upon the most vulnerable – Argentina, Brazil, Turkey, South Africa, say, whereas key Asian nations will be relatively calm – India, China, Indonesia, Korea and Taiwan.

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I do feel that headline US unemployment will be lower by then and that there will be a burgeoning realisation that we shouldn’t devalue that because of low participation rates. Widespread academic research has highlighted that a large proportion of the fall in participation rates has been caused by demographics – to somewhat over-simplify, baby boomer retirees – and is not going to race back up cyclically. Finally, US economic data will finally be free of both government shutdown and weather distortions, and looking very healthy.

Here in the UK, the BOE faces a very similar dilemma and Wednesday’s release of the Bank’s Quarterly Inflation Report (QIR) will surely unveil tweeks to forward guidance. As in the US, unemployment is crashing, and last week’s January UK Services PMI Reading, although only a tad lower at 58.3, from 58.8 in Dec, boasted sub-components that still made excellent reading, with the key employment index moving higher, along with the outstanding business index which, at 55.3, stands at its high since 1997. At this rate Q1 growth is looking like 1.0 per cent qoq.

I do not expect the QIR to announce a reduction in the unemployment threshold to 6.5 per cent, say, but I do expect to see a nod to other metrics, such as wage and productivity growth. There must also be a 25 per cent chance that they take a leaf out of the Fed’s book and introduce a version of the Summary of Economic Projections, with a record of individual MPC members’ views on the future path of the Bank’s Base Rate. In short, RIP forward guidance, long live old-style insight into the MPC’s thinking and reaction function.