MNI EXCLUSIVE: Fed Needs til Dec to Meld Framework on Guidance

The Fed will wait until December or longer to clarify forward guidance implementing the shift to average inflation targeting, but new 2023 projections in the September dot plot should guide markets toward a later lift-off date, former senior officials told MNI.

There's little urgency to pledge near-zero rates for a specific period of time or until some economic threshold is met, because there's no assurance Covid-19 is under control or the U.S. economy is in a sustained rebound, sources said. Congress failing to pass another fiscal aid package poses another risk, so staying out of the way also keeps up pressure to enact more stimulus, they said.

"They will be giving it a couple more months before bringing out the heavy guns," former Richmond Fed President Jeffrey Lacker told MNI. The Fed is waiting to see whether the economic rebound remains stalled or resumes a brisker pace before issuing outcome-based forward guidance on rates and asset purchases, he said.

A new Summary of Economic Projections at the September 15-16 meeting that extends the forecast horizon to 2023 could illustrate a "general intent to be more dovish than in the past," Lacker said. "That's the kind of thing you would see, that they would tolerate two-and-a-quarter maybe even two-and-a-half percent core inflation over the course of three years or more In a row."

Persistent Overshoot Needed

Nathan Sheets, a top Fed and Treasury official, now chief economist at PGIM Fixed Income, anticipates only one additional dot supporting a rate hike by 2023. "It's a persistent overshoot they've got to achieve, and that's a high bar. (In June) you had two dots above zero and this time you'll have three, and all the rest will be at zero," he told MNI.

Trying to jolt short-term rates now would likely add little to the QE already in place, and the Fed was also wise in July to state that it still has flexibility to respond at any point to the evolution of the pandemic, Lacker said. "They've done a lot in asset purchases, so it's not clear they would be able to generate the same shock and awe that shifts expectations," he said.

Former Atlanta Fed President Dennis Lockhart also told MNI the Fed is likely to take some time before weaving in the new framework. "Current conditions don't call for implementation of the new approach," he said.

"To the extent that forward guidance is a policy tool to add stimulus, it may be premature, or it may be adding stimulus in a potentially rapidly shifting economic picture," Lockhart said."If we see an acceleration of inflation to above 2%, the committee will let the economy run and measured inflation to continue above target for potentially a long while."

Jobs Goals

While the Fed has set its new average inflation goal, it hasn't said how it's going to get there. Part of the answer will be embedded in the specifics of its outcome-based forward guidance, still very much under debate.

Bill Nelson, former Fed deputy director of monetary affairs and current chief economist at the Bank Policy Institute, anticipates inflation-dependent guidance. The Fed will specify that rates remain near zero for "at least as long as 12-month PCE inflation measured over a two-year period averages 2 percent or less," he said. That implies the Fed would let unemployment fall without limit, he said in an email newsletter Friday.

Others expect a more explicit reference to a job market objective, especially given the difficult process of bringing workers back. "It's hard to imagine," Lockhart said, "that the committee would remain silent on employment in laying down a marker as to how long we'll have the policy rate at the zero lower bound."

Communicating labor market conditions that would prompt a withdrawal of monetary stimulus -- in light of the Fed's new "broad-based and inclusive" goal -- will be a separate challenge, he said.

Fiscally Active