Watch This Space: Vice-Chair Clarida Tipped Fed’s Hand On Slowing Rate Hikes

Watch This Space: Vice-Chair Clarida Tipped Fed’s Hand On Slowing Rate Hikes  | Dec 03, 2018 02:18AM ET

Market participants need to start paying closer attention to Richard Clarida, the Federal Reserve's new vice chairman. He's the one who let the cat out of the bag last week, about the US central bank slowing down its pace of interest rate hikes, a day before Fed Chairman Jay Powell confirmed it.

Though Fed officials couch their stance in terms of flexibility and data dependency, what it ultimately comes down to, as investors quickly realized, is that the central bank is not likely to go ahead with three or four rate hikes next year even if they do proceed with the expected hike in December.

In his speech on Tuesday, Clarida noted that members of the Federal Open Market Committee (FOMC) have consistently lowered their estimates of the natural levels of unemployment (u*) and the neutral rate (r*) in response to what is actually happening before their eyes. As the former Columbia University economics professor and PIMCO adviser put it, in the “real world,” policymakers have to look at the data fresh at each meeting. They have to abandon any notion of where they think the economy is going and how fast monetary policy needs to adapt.

Powell then came along the next day to affirm all this in his much-ballyhooed speech Wednesday to the Economic Club in New York. He said the Fed’s current rate is “just below” that neutral rate, even though it hasn’t budged since October, when he said it was far away. Even allowing he means to include the December hike, it’s fairly clear he has lowered his estimate of where the neutral rate lies, just as Clarida said.

Powell also sent pulses racing when he said there is no “preset” path for interest-rate increases. As we learned a day later when the minutes of the early November FOMC meeting were released, this is exactly the wording used in the discussion by participants then.

“They noted that their expectations for the path of the federal funds rate were based on their current assessment of the economic outlook,” the minutes said. “Monetary policy was not on a preset course.” The panel discussed at length the need to change the consensus statement to reflect this flexibility in responding to economic data.

The reason to pay attention to Clarida is that he is now the ranking economist on the board of governors. Powell, whatever his strengths vis a vis consensus-building, is not equipped to be a thought leader in understanding the economic forces at work in determining monetary policy.

In his speech last week, Clarida deftly reduced the reasons why inflation is still lagging behind the Fed’s 2-percent target, as measured by the personal consumption expenditure (PCE) index the Fed prefers, because labor participation is still short of where it was before the financial crisis and productivity has finally started to improve more rapidly. In short, there is little danger of a Phillips curve kicking in and pushing up wages even if unemployment goes even lower.

It ultimately doesn’t matter whether the new dovishness at the Fed is due to pressure from President Trump or is simply the result of policymakers seeing the impact of the interest-rate increases on the economy. Some commentators, such as The Wall Street Journal editorial board, were at pains to emphasize Trump’s tweets played no role whatever, and the Fed has simply come around on its own to see things Wall Street’s way.

Others, such as maverick analyst Richard X. Bove, scoffed at that, saying, of course it made a difference, as presidential pressure always has—and should. Notwithstanding the catalyst, the fact is, the Fed will slow down.

Every meeting next year will be “live” in the sense there will be a press conference afterwards so that changes in monetary policy can be fully explained, but that doesn’t mean there will be a lot of changes. The Fed funds futures prices show the probability of an increase after December rises above 50 percent only in June or July.

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