A flurry of communication has come out of the Fed in recent days – from hawks and doves alike – all focused on the need to change forward guidance on interest rates. As we’ve discussed, the particular concern the Fed has at this point is how to break from its gradualist language of keeping rates low for a ‘considerable time’ after it ends asset purchases in October. Should the economy continue to surprise on the upside, this language could only serve to hamstring a central bank that may have to act quickly to bring its policy stance more in line with economic reality.
In an ideal world, the Fed would like to have the path of interest rates directly tied to progress on its stated goals of maximum employment and 2% inflation. The only problem with this approach is that nobody – not even the Fed – knows exactly where maximum employment is, given how much may have changed in the labor market during the Great Recession. Chairwoman Yellen’s so-called labor-market ‘dashboard’ attempts to address this problem by adding texture to what’s going on under the surface of the headline unemployment number. The dashboard compares the current state of various labor market indicators to their pre-recession peak values. The indicators can be broken down into various leading and coincident indicators; Yellen’s primary focus has been on the “Utilization” quadrant, or essentially the segments that measure whether the labor force is currently working to its fullest potential:
We think the Atlanta Fed’s spider chart version of the dashboard does a nice job of showing progress in each area over time. However, seeing it in full relief like this highlights an absurdity of this type of benchmarking; you’re forced to pick what you consider the ideal moment in time against which to measure progress. And nobody – not even the Fed (we hope) – thinks that the December, 2007 economy-on-credit-steroids represented a normal state of labor markets.
By this look, it’s not surprising the Fed is interested in introducing more flexible language into its forward guidance. The Fed is closer to its goals – and quite possibly uncomfortably beyond a few of them – than many market participants may appreciate. The current ultra-loose stance of monetary policy is increasingly out of whack with the where the Fed wants to be; whether markets hear that message and how they digest it is another question altogether. To paraphrase Loretta Mester, the new head of the Cleveland Fed, from last week: expect more volatility in financial markets as a result.