4. Clarify the 12 December policy announcement
Starting in August 2011 the Fed conditionally promised to keep its benchmark interest rate near zero for at least two years or so, repeatedly pushing its rate guidance outward, from mid-2013 in August 2011 to mid-2015 more recently. The repeated changes have created pessimism by giving the impression the Fed lacks confidence in the vigor of the economic recovery. This is likely one reason why the Fed on 12 December scrapped its calendar approach in favor of economic thresholds. From now on, the Fed’s decision to raise the federal funds rate will depend on either the unemployment rate reaching 6.5% or inflation reaching 2.5% in the Fed’s one-to-two year forward projections.
While the calendar approach was clear and allowed the Fed to reduce uncertainty and suppress volatility, we believe the new approach is less clear. For starters, the unemployment rate is an imperfect indicator of the employment situation and can be significantly affected by changes in the size of the workforce and other factors. In addition, the Fed’s inflation tolerance is based on a forecast and its own, no less. How are investors to know day-to-day what that forecast is or how it might be evolving? We think the Fed should clarify its new policy and give investors the proper lens to view it with.
Cart data from Bureau of Labour Statistics (Unemployment) and InflationData.com (inflation - CPI-U)