Federal Reserve officials have raised interest rates this spring, even before they meet next week to vote on monetary policy.
They tightened monetary policy, raising the cost of borrowing and putting downward pressure on prices, not by changing their interest rate target, but simply by talking.
Recent chatter over the past few months from Fed Chairwoman Janet Yellen and other officials has served to convince investors that rates are rising faster than previously thought, and those investors in turn have bid up interest rates on short-term bonds.
“By talking them up, they are effectively raising rates already,” said David Beckworth, an economist at Western Kentucky University.
The episode is an illustration of how the central bank can influence the cost of credit throughout the economy, including for consumer products such as credit cards or savings accounts, simply through speech.
After the Fed raised its target rate in December and immediately saw financial markets suffer turmoil and economic growth slow to a near-standstill in the first quarter, investors bet that Yellen and company would shy away from further rate increases for a while. Fed officials appeared to encourage the perception that they favored looser money for longer. In particular, Yellen in March sounded dovish in both a press conference following the Fed’s decision not to raise rates and a speech in New York City, emphasizing factors that weighed in favor of waiting to raise rates again.
The same considerations convinced investors that the Fed wouldn’t be tightening money quickly. Even though unemployment is nearly back to normal, other indicators suggest that overall spending is below where it could be. Inflation has continued to run below the Fed’s 2 percent target, which hasn’t been met in four years. Slowing growth in China and elsewhere overseas could hold back U.S. spending and inflation. U.S. growth has remained tepid.
Looking at those realities, markets guessed that the Fed would respond by keeping monetary policy stimulus in place. As late as mid-April, futures market prices suggested that investors saw just single-digit odds of rate increases in June and July.
But then the Fed surprised all the Fed-watchers. In mid-May, the central bank released minutes from its April meeting that showed that most Fed officials thought that they should raise rates in June if the economy held up.
Then several Fed members in public speeches backed up that account, culminating in Yellen saying in an interview in late May that a rate hike would “probably” be appropriate over the summer if growth continued at the same pace.
Now, markets suggest that there are a better-than-even odds that the Fed will act to raise rates by July and a possibility that it could do so in June.
That’s good from the Fed’s point of view, because central bank officials do not want markets to get out of sync with their plans, something that some members, earlier in the spring, warned was happening.
Beata Caranci, chief economist for TD Bank Group, suggested that the Fed wouldn’t want to raise rates unless markets saw it coming, and specifically unless investors were placing odds of above 60 percent of a rate increase.
“The Fed doesn’t want to be a source of volatility in the markets,” Caranci said. Yellen and her colleagues would prefer if, by the time they actually gave the order to raise short-term interest rates, the decision was so fully anticipated that there was almost no market reaction.
Even more importantly, perhaps, the market has in effect partially carried out the rate hike, before the Fed’s decision.
The Fed’s “talking up” rate hikes, has been priced into contracts like Treasury securities and, most importantly, the dollar, Beckworth said. Those price changes, as well as the expectation of more rate hikes in the future, have changed spending plans for companies and individuals already.
“They definitely are trigger-happy. That trigger finger’s just itching to pull,” said Beckworth, who cautioned that the Fed may have tightened too much and too fast already.
In other words, much of the monetary policy action has taken place, even before Fed officials fly to Washington to officially vote on policy June 14 and 15.
And it may be that the 2 p.m. announcement of the committee’s monetary policy decision will be overshadowed by Yellen’s comments in her subsequent press conference or before the Senate Banking Committee when she speaks there on June 21.
