Federal Reserve Vice Chairman Stanley Fischer left the door open for a Fed rate increase in September, saying the factors that have been keeping inflation below the central bank's target level have likely begun to fade.
Fischer said there's "good reason to believe that inflation will move higher as the forces holding down inflation dissipate further." He said, for example, that some effects of a stronger dollar and a plunge in oil prices have already started to diminish.
The vice chairman's remarks came in a highly anticipated speech at an annual conference of Fed officials in Jackson Hole, Wyoming. Investors have been trying to determine whether the Fed might still be on course to raise rates after its Sept. 16-17 meeting given recent market turbulence, which had raised doubts.
With Fed Chair Janet Yellen having decided to skip this year's Jackson Hole meeting, Fischer commanded top attention Saturday on a panel on inflation dynamics with other top central bankers from Europe and India that wrapped up the conference.
While Fischer was careful to announce that he wasn’t signaling an impending rate increase, the remarks suggested a move wasn’t ruled out for when the Federal Open Market Committee gathers in Washington, D.C., on Sept. 16-17.
“He was very clear that September is still on the table, though he made no promise about it,” said Randall Kroszner, an economics professor at the University of Chicago and a former Fed governor who attended Jackson Hole.
Investors have pushed up the probability of a Fed move next month to 38 percent late Friday in New York, from 24 percent on Aug. 26, according to trading in federal funds futures. They see a 49-percent chance of a move in October.
“It sounds to me as though in his heart of hearts, he would like to tighten in September. But others on the committee are more hesitant, like Bill Dudley,” said Jonathan Wright, a professor at Johns Hopkins University in Baltimore and a former Fed economist who attended Jackson Hole this year.
New York Fed President William C. Dudley said Aug. 26 that market turbulence made the case for a September move “less compelling to me than it was a few weeks ago.” The Standard and Poor’s 500 Index is around 4.5 percent higher since he spoke.
“It is a very finely balanced decision, and I don’t think that the Fischer speech moves the odds on September very much,” said Wright, who had viewed liftoff prior to Fischer’s remarks as a “coin-toss” between September and December. “The next jobs report will get a lot of weight in the decision,” he said.
The Fed has said it will be appropriate to raise rates when it has seen some further improvement in the labor market and is “reasonably confident” inflation will move back to its 2-percent target over the medium term.
Several months of strong job creation have reduced unemployment to 5.3 percent, the lowest level since April 2008. Fischer said “we now await the results of the August employment survey, which are due to be published on Sept. 4.” Economists forecast a 220,000 August gain, up from the 211,000 gain averaged so far this year.
Yet inflation, measured by the Fed’s preferred gauge, has been under the bank’s target for more than three years. Price pressures in the U.S. rose 0.3 percent in the 12 months through July, held down by oil’s decline and a strengthened dollar.
Kroszner said Fischer’s comments were revealing in that they emphasized the forecast for inflation over the current level.
“Stan made clear we can’t just look at the past data, we have to look where inflation is going,” he said. “He’s not going to be constrained by low current inflation because he wants to make sure we stay ahead of the curve.”
Fischer showed confidence in the Fed’s predictive powers at an event where several of his peers acknowledged that economists had a miserable record of forecasting inflation.
Athanasios Orphanides, a professor at the MIT Sloan School of Management and a former senior adviser at the Fed Board in Washington, said economists should show more “humility” when it comes to predicting future inflation.
“In practice we don’t know how to do these things very well, and assuming we do know when we don’t is a recipe for disaster,” Orphanides said Friday.
Fischer got support for his confidence in a paper delivered Saturday by economists Jon Faust of Johns Hopkins University, a former special adviser at the Fed, and Eric Leeper from Indiana University. They argued falling unemployment would “at some point” put upward pressure on wages and inflation.
“We can be confident based on our slack measures that inflation will soon be rising,” they wrote.
Other central bankers also shared Fischer’s optimism. Bank of England Governor Mark Carney said the prospect of China’s slowdown hurting inflation or market turmoil restricting credit in the UK “needs to be monitored, not taken for granted.”
Then there was Li Daokui, a professor at Tsinghua University and a former academic adviser to the People’s Bank of China. He called his country’s recent stock-market plunge a “healthy” price adjustment and said China could still expect to grow by 7 percent annually.
Healthy or not, China’s market turmoil ended up spreading to the U.S., wreaking havoc in stocks and bonds in the week leading up to the Teton mountain gathering. In the five trading days through Aug. 24, the S&P 500 Index dropped 10 percent.
As they arrived in Jackson Hole mid-week, Fed officials across the policy spectrum shrugged off investor worries that financial markets were on the verge of a meltdown.
“The key question for the committee is, how much would you want to change the outlook based on the volatility that we’ve seen over the last 10 days? And I think the answer to that is going to be: not very much,” said St. Louis Fed President James Bullard, who favors raising rates.
Word of caution
Minneapolis Fed President Narayana Kocherlakota, who wants the FOMC to wait at least until 2016 before moving, agreed.
“Should it cause a change in our outlook for inflation and unemployment going forward? There I think my own answer would be no,” he said.
Kocherlakota did, however, sound a note of caution. If market movements are a signal that investors see a deeper slowdown coming in China, that could mean more fundamental problems lay ahead.
“If there is a shortage in aggregate demand going forward, how will central banks respond? Will they have the will or the capacity to respond effectively to bring inflation up to their mandated goals?” Kocherlakota asked.