FedWatch: Are Fed hawks and doves on a collision course?


Federal Reserve policymakers today modified their language describing economic conditions, upgrading the characterization of the labor market slightly, acknowledging the solid bounce in economic activity in the second quarter and noting the recent increase in inflation. At the same time, they hedged a bit, adding new language that notes a “range of labor-market indicators suggests that there remains significant underutilization of labor resources.’’ As expected, the policy-setting Federal Open Market Committee (FOMC) also voted for another $10 billion of tapering—staying on track to bring an end to quantitative-easing’s asset purchases by late fall. 

All that said, the most intriguing elements of the FOMC discussion that likely took place over the past two days will be left for another day. Specifically, there clearly appears to be an evolving split on the committee that has some regional Fed presidents advocating consideration of a sooner “lift-off” for the Fed’s target short rates, while Chair Janet Yellen and others seem comfortable waiting until further resource slack—most notably in the labor market—has been absorbed. Aside from the dissent by Philadelphia Fed President Charles Plosser, who felt the patience implied by the FOMC statement “does not reflect the considerable economic progress that has been made toward the Committee’s goals,” we will have to wait until minutes from the two-day meeting are released in three weeks to get more insight on the extent of this hawks vs. doves debate.

It’s a good bet that this morning’s initial take on second-quarter growth added fuel to those discussions. The estimated 4% increase in real GDP was significantly higher than Wall Street consensus, and repriced bond market yields higher. The GDP bounce, combined with an estimated 2% annualized increase in the core Personal Consumption Expenditures Price Index in the second quarter, may have added credence to those at the Fed who see the economy approaching normalcy and the need for radical monetary accommodation fading.

Much has been made of how Yellen seems relatively dismissive of inflation while homing in on the quality and sustainability of improvements in labor market—signals consistent with her so-called “optimal control” bias. Optimal control, as we noted last week, is wonk-speak for a modeling approach that seeks to minimize the deviation of the Fed’s key variables (inflation and unemployment) from their presumed “target” levels, and explicitly considers trade-offs arising from allowing one variable (inflation) to overshoot in order to drive the other variable (unemployment) down more rapidly. It appears we may be heading into a period where the theoretical model and the reality of a diverse FOMC may be starting to collide.