Forget rate hike, Fed could reverse course

Give the Federal Open Market Committee credit, they are not stubbornly holding to the confidence in growth they espoused in December. They are, it appears, carefully backing away from their upbeat assessment by acknowledging the economy isn't rolling along quite as well as they expected.

Then again, the economy wasn't really going along that well in December, but they were determined to get the first move done, after having been stymied by events in September. We can also guess from their softer tone in assessing the economy that fourth quarter gross domestic product growth will be too low to support further tightening.

Traders in the Standard & Poor's 500 stock index options pit at the Chicago Board Options Exchange (CBOE).
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Traders in the Standard & Poor's 500 stock index options pit at the Chicago Board Options Exchange (CBOE).

As for the timing of the second move, it depends, and this is really the critical aspect of this statement. The markets, beginning more than 18 months ago, started to price in a trajectory of higher policy rates, following what the Fed was communicating. Capital markets reacted as if monetary policy had already shifted and recovered when the proposed trajectory for policy flattened.

Since the year began, the drop in global equity markets moved participants in the U.S. Treasury market to push out the timing of what the Fed will do. At some point, this should be supportive of equities. What today's statement does, in effect, is formalize what the markets have already done.

Reading further into the statement, the FOMC appears to have opened the gate for moving in the opposite direction, if the data warrant, by writing "The Committee is closely monitoring global economic and financial developments . . . for the balance of risks to the outlook." In December, the FOMC saw "the risks to the outlook . . . as balanced."

This, from our perspective, is Fedspeak for saying events now lean towards impacting the economy negatively. If their worst concerns come to pass, they will reverse course. Fed Vice Chair Stanley Fischer has said as much — the tightening cycle doesn't mean an ease or two couldn't occur along the way.

In terms of their assessment of the economy, they separated improvements in the labor market from the economy as a whole. It must be frustrating to them that growth in hiring isn't translating as it has in the past. This is life in a near zero real interest rate economy, a falling capital/output ratio with no inflation.

Getting back to their view of the economy, growth in household and business spending was reduced to "moderate" from "solid" and they added slower inventory investment to net exports as negatives for overall growth.

They also pushed out the timing on the return to 2 percent inflation as the "transitory effects of declines in energy and import prices dissipate. . . " because today, unlike six week ago, "Inflation is expected to remain low in the near term, in part because of the further declines in energy prices, . . . "

As for inflation expectations, among market-based measures, which were "low" six weeks ago, have " declined further." Survey-based measures are "little changed, on balance, in recent months" after having "edged down" six weeks ago.

In sum, if markets end up seeing this statement as formalizing the flattening and lengthening of the trajectory the markets have been pricing in during the past several weeks, the statement could end up as a positive for the equity markets.

This statement wasn't a reversal of December's policy move or the start of a fourth round of quantitative easing, it was simply an acknowledgement that the Fed is not tied to any particular direction, especially now that global forces are tilting the balance of outcomes towards the negative.

Commentary by Steve Blitz, director and chief economist, ITG Investment Research. Follow him on Twitter @sblitz1

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