The Federal Reserve held its target range for the federal funds rate at 3.5 to 3.75 percent on Wednesday, over the objections of three committee members, Beth Hammack of Cleveland, Neel Kashkari of Minneapolis, and Lorie Logan of Dallas, who preferred a quarter-point increase. A hold was the likelier bet but far from a sure one: on the eve of the decision, futures put the odds of a quarter-point increase at 31 percent.
The statement could have been mistaken for June’s. Economic activity is “expanding at a solid pace,” inflation “remains elevated relative to the Committee’s two-percent goal,” and supply shocks again take part of the blame. What changed was the vote. Six weeks ago the committee’s decision to hold rates steady was unanimous; on Wednesday, three of the 12 members voted to tighten.
At his second press conference as chairman, Kevin Warsh described an economy showing “impressive resilience,” with job gains keeping pace with the workforce and unemployment little changed. On inflation, he conceded that “five years of high inflation have left a mistaken impression that is hard to shake: that the Fed’s implicit inflation target was somehow above two percent.” His answer: “There is no soft inflation target, there is no soft implicit target — not on this Committee’s watch. There is only a target, and it is two percent.”
The development he chose to highlight was in the bond market. Nominal and inflation-adjusted “real” yields moved “materially higher across the Treasury curve” between the meetings, increases “among the most significant in the last two decades.” The ten-year Treasury yield rose from 4.43 percent to 4.61 percent, and the real ten-year yield climbed from 2.14 percent to 2.41 percent.
Warsh welcomed the move. Now that the Fed has stopped telegraphing its next moves, the practice known as forward guidance. Investors are pricing the data rather than parsing the Fed, “learning to play the ball, not the referee.” He called the shift “a change for the better — and we are just getting started,” adding that “the central bank need not always and everywhere be the center of attention.”
But consider what the market is saying. Yields rose because the data, inflation still well above target and growth still solid, point toward higher rates, the same conclusion three of Warsh’s colleagues reached inside the meeting room.
The dissenters had the stronger case. Inflation has run above two percent for more than five years, and the committee’s own June projections put it at 3.6 percent this year, revised up from 2.7 percent in March. Warsh himself sketched the relevant rule for reporters: a central banker who has met the employment side of his mandate and sees underlying inflation moving higher leans toward tightening.
On the eve of the meeting, standard policy rules, formulas that translate inflation and economic conditions into a recommended interest rate, prescribed a federal funds rate between 3.76 and 6.01 percent, every one of them at or above the top of the Fed’s current range. By any of those rules, Wednesday’s vote should not have been close.
The best argument for waiting was June’s consumer price report, which showed prices falling 0.4 percent. However, Warsh acknowledged that five-plus years of above-target inflation “cannot be cured in nine weeks — or by a single month of modest price decreases.”
Standing still, moreover, is not the same as standing firm. Interest rates across the economy have been rising because borrowing demand is strong and inflation has stayed high. When the going rate for money rises and the Fed keeps its own rate fixed, policy does not stay put; it gets easier, the way someone standing still on a down escalator drifts lower. On Wednesday the Fed did not simply decline to tighten. It let policy loosen, with inflation still running well above its target.
Asked why the funds rate should not already be higher, Warsh answered that rates are higher than they were 42 days ago, the market saw to that. But the market cannot do the Fed’s job. Treasury yields rose in part because investors expect the committee to deliver the increase it just declined to make: futures put the odds of a quarter-point hike in September at 62 percent. If the Fed never follows through, those market rates will come back down, and the tightening Warsh welcomed will disappear with them.
To be sure, Warsh has led the Fed for barely two months; the inflation problem he inherited is more than five years old. But inflation, as he has long argued, is a choice the central bank makes, and on Wednesday he said the Fed’s credibility “rests on performing our duties, and delivering on our responsibilities.” For a central bank that has missed its target for five years, performing means one thing: getting inflation back to two percent. Wednesday’s decision moved policy away from that goal, not toward it.
