The Fed Cannot Agree On Where Rates Already Are

On September 4, Cleveland Fed President Hammack said Fed policy is not restrictive, that inflation is too high, and that local contacts indicate it is time to raise rates. On September 3, Governor Waller said he leans toward a September hold, that mortgage rates and auto loan rates are not low, and that "loose financial conditions" is really a reflection of stock prices. Governor Barr said on September 1 that a hike will be necessary if inflation does not moderate soon. New York Fed President Williams said on September 2 that rising long yields reflect a strong economy and strong investment demand rather than the inflation outlook. Markets price roughly a two-thirds chance of a hike on September 16.

Every count of this committee is being reported as hawks versus doves. Three lean hike, one leans hold, one is undecided. That framing misses what is actually being said. A hawk and a dove agree on where policy is and disagree about where it should go. That is a normal committee and it produces a normal reaction function — you can model it, and the market can price it. This is a different disagreement. Hammack's position is that policy is not currently restraining the economy. Waller's is that borrowing costs are already high and the only thing that looks easy is the equity market. Those two statements cannot both be true. One of them thinks the committee is standing below neutral and the other thinks it is standing above it, and neither has been contradicted by the other because the argument is being conducted in speeches rather than at a table. That matters more than the September decision, because it means there is no shared map. A committee that agrees on its location but not its destination will get there eventually. A committee that does not agree on its location cannot tell the market what it will do next, in any state of the world, because the members are answering different questions. Which is worth reading against what the Chair said at Jackson Hole. Warsh explicitly declined to offer forward guidance or a formal reaction function, and said market participants should not be looking primarily to the Fed for their next trade. That has been read as a stylistic preference for a quieter central bank. It is also what you would say if the reaction function did not exist to be described. The market is trading the September meeting as a coin flip on data. The more durable question is what happens at the meeting after it, and the meeting after that, when the same five people are still working from different assessments of where they already stand.