Net Net: Promoting innovation and managing change
Net Net: Promoting innovation and managing change

Fed closer to 'monetary Y2K,' but not there yet

Friday's job report: By the numbers

The last of the big economic data points is in. Now it's up to the Federal Reserve to start sending clear signals to the financial markets regarding its interest rate intentions at its meeting later this month.

Market confusion over the course of policy itself could be the Fed's biggest enemy at a time when markets are in flux and volatile. Investors are concerned over how and when the central bank will proceed amid a flurry of mixed signals.

"The heightened uncertainty about whether the Fed will go in September was not what the Fed was hoping for," Ryan Sweet, an economist at Moody's Analytics, said in a phone interview. "They've had September circled for some time. The plan was in late August to start signaling that they're going. The last thing they want to do is surprise markets. From a communication perspective, September is much more difficult than the Fed was hoping it would be."

Friday's nonfarm payrolls report showed the economy created 173,000 jobs in August, a number less than expected but likely to be revised substantially higher in the months ahead if historical trends hold. Other recent U.S. data points show an economy on the mend, though third-quarter gross domestic product appears to have slowed quite a bit.

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Sweet still thinks the Fed will lift off this month, but he makes way for the possibility that the uncertainty could lead to a further delay. Should the Federal Open Market Committee move on rates at the Sept. 16-17 meeting, he expects Chair Janet Yellen to signal a "one and done" approach that will see a single rate hike this year then no further moves until sometime in 2016.

A Federal Reserve police officer walks past the Federal Reserve building in Washington, D.C.
Andrew Harrer | Bloomberg | Getty Images

The market is split: Most Wall Street economists forecast a September move; Goldman Sachs is a notable exception with a December projection. But traders, as measured through CME futures contracts, assign just a 19 percent chance to a September hike, a number that plunged Friday from 27 percent the day before.

Broadly speaking, the Fed finds itself in a ticklish position: Should it renege on a rate hike it's been signaling for months, it would risk a loss of credibility, while hiking rates could disrupt a fragile global ecosystem.

In public remarks, Fed officials generally have been noncommittal about a rate hike. That, coupled with the lack of clear economic signals, probably keeps the FOMC on the sidelines a bit longer, said Mohamed El-Erian, chief economic adviser at Allianz.

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"It's a close call," El-Erian said in an email to "With such an intense tug of war between improving domestic economic conditions and fragile international ones, I suspect that the Fed will end up waiting, especially as it will not wish to fuel global financial instability."

The Fed has never been able to articulate just how much a quarter-point hike from near-zero would mean to the world's largest economy. But investors have recoiled at even the slightest hints of tightening.

Markets have been almost perfectly correlated with the Fed's quantitative easing, a $3.7 trillion bond-buying program implemented in three phases since late 2008. Low interest rates have fueled a bonanza in share buybacks and dividend issues which, combined with QE, have catapulted the about 190 percent since the March 2009 lows.

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How much the Fed's first hike since June 2006 disrupts the flow further is a matter of hot debate on Wall Street.

"This could be monetary Y2K," Prudential Financial strategist Quincy Krosby said in reference to fears, ultimately unfounded, that the new millennium would crash global computer systems. "You finally get the nervousness out of the system and move on."

Inside the mind of the Fed

Yellen and other Fed officials have pushed market participants to focus not on the timing of the rate hike but rather the trajectory, which they say will be gradual and aimed at not disrupting the system.

However, delaying a hike well past the end of the Great Recession, coupled with continually adjusting its economic data targets for moving, already may have cost the Fed dearly in credibility. The latest uncertainty over a rate hike is a manifestation of a market forced into a guessing game by a Fed that promised to be clearer with its intentions.

That's been complicated by dueling pressures, from some in the market who want normalization against global leaders who think the Fed should wait until things stabilize.

Read MoreFed won't hike rates into volatile market: Economist

"You expect the pope to come out and say don't raise rates," Krosby said.

"There's never a good time to raise rates," she added. "They've put themselves in a corner. They should have raised rates earlier. Maybe just for the sake of being a good citizen in the global community she holds off."

Markets weren't happy Friday with the state of affairs, with major averages off sharply amid the confusion.

"Market participants almost are nostalgic for the days that the Fed was mysterious. It's this constant open-mic season" now, Krosby said. "Normalizing (rates) helps move us closer to fundamentals. The Fed, by not moving, essentially keeps us tied to their every word."