What Does The Fed Do Now? The FOMC Decision Tree
Here, for those who naively still think the Fed is data-driven, here is Nomura’s full decision-tree.
But back to the $64TN question: what does the Fed do? One attempt at an explanation taking into account last week’s market plunge comes from Nomura, which provides a “2015 Scenario Analysis” in which it “breaks down various monetary policy (rate hike options) and rates market implications ahead.”
This is the summary:
The minutes to the July meeting revealed that the Committee has doubts about a variety of aspects of the economic outlook, including growth, inflation, and developments abroad. Incoming data since the July FOMC meeting have not really answered those questions, all the while financial conditions have tightened materially recently. As such, we believe that the probability the FOMC will raise short-term interest rates for the first time in September has decreased materially while the probability of liftoff in December or no interest rate increase this year has increased. We now only put a 20% probability of liftoff in September (previously 35%) while we have raised the likelihood of liftoff in December to 44% (previously 40%) and liftoff after December to 36% (previously 25%).
Here are the details broken down by meeting:
The September FOMC meeting
We think there is only a 20% likelihood that the FOMC will decide to raise interest rates at its meeting in September. The minutes to the July meeting revealed that the Committee has doubts about a variety of aspects of the economic outlook, including growth, inflation, and developments abroad (see Minutes of the July FOMC Meeting, Policy Watch, 20 August 2015). Incoming data since the July FOMC meeting have not really answered those questions. Moreover, developments abroad, notably in China, have raised new questions about the outlook for the rest of the global economy. Last, as noted above, financial conditions have tightened materially.
A decision to raise interest rates at the FOMC meeting in September would probably require a combination of factors. The economic data released between now and the meeting—both real side and inflation—would have to surprise to the upside. Developments abroad and financial conditions would have to stabilize. There would have to be a strong consensus within the Committee on the need to start the interest rate adjustment sooner rather than later. This is certainly possible, but it does not seem likely.
We will get some new data between now and the September FOMC meeting (see Fig. 10). But the amount of additional information that the FOMC will have at its September meeting will be limited. An important reason why we doubt that the FOMC will raise rates in September is that there simply isn’t enough time to answer the questions that the Committee seemed to be struggling with at its meeting in July.
The December Meeting
If the FOMC does not raise rates at its meeting in September (and it stays on hold in October), the issues that will drive a decision in December are mostly the same. That is: a decision will depend on the outlook for growth and inflation, financial conditions, and developments abroad. We think there is a good likelihood (55%) that the economy will have evolved in a way that leads the FOMC to initiate liftoff in December. We think that positive fundamentals for consumers will drive stronger spending. We think that investment will recover as drilling activity in the oil gas sector stabilizes. We think that housing activity will continue to grow at a healthy pace. We think that growth in China will remain on target and that financial conditions are likely to stabilize. We think that labor markets will continue to improve. We think that a forward-looking assessment of inflation will be more positive. The additional time between the September and December meetings will make all of these positive developments apparent.
Of course, there may not be enough progress on these measures to convince the Committee that it is time to raise short-term interest rates. Moreover, concerns about year-end issues may cause it to delay liftoff until next year.
For what it’s worth, we remain in “concerns about year-end issues” camp (clearly the Fed realizes there is nothing quite as destructive as 6 inches of snow to the Apple Sachs Industrial Average, pardon the world’s biggest economy as the past two “harsh winters” have shown), or in the worst case: a rate hike followed promptly by QE4.