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The decision to raise short-term interest rates will be the easiest part of the meeting of Federal Reserve officials later this month. Hearing on how to set the path for rate increases next year could prove much more difficult.
Strong US growth, low unemployment and stable inflation should prompt the Fed to raise its key rate this month from its current range of 1.75% to 2%. According to interviews and public speeches, officials are likely to relaunch it in December if trade disputes or volatility in emerging markets do not jeopardize global growth.
They could also drop the wording of their statement after the meeting to say that for years, monetary policy has been "accommodating," meaning that rates are low enough to stimulate economic growth.
Deleting the language now, while rates are not yet at a "neutral" level that does not stimulate or slow growth, would avoid sending potentially misleading signals about where such a parameter is. If officials wait to drop the language until the rates are higher, they could signal an unexpected accuracy around their neutrality estimate.
As rate hikes this month and in December are highly anticipated, the market's reaction may depend on the evidence provided by officials about what will happen in 2019 and beyond.
In June, officials announced two new rate increases this year, three next year and one in 2020. They will update these projections at their September 25-26 meeting. Futures imply that markets are seeing the Fed raise rates twice more this year and almost twice as much next year, according to Citi.
Until now, predicting what the Fed would do was relatively simple for investors. The authorities look forward to withdrawing their emergency stimulus measures, which have lasted much longer than planned.
The only question was whether the economy would be strong enough to do it. Authorities have benefited from solid growth to strengthen policy at every meeting since December 2016.
Next year, the debate could change. With some additional increases, short-term rates will approach neutral estimates by government officials, although there is still much uncertainty about the current situation.
A camp sets the stage to continue gradually increasing rates to deliberately slow down growth and prevent overheating. This group is driven by models, embedded in the Phillips curve, where inflation changes inversely with unemployment.
Although this relationship has been weak in recent years, many officials still believe the framework is worthwhile. They believe that inflationary pressures will develop, requiring a tightening of money, as long as unemployment remains below its long-term estimated level and the economy grows faster than its estimated long-term growth rate.
Another camp is preparing to say that as long as inflation remains close to the Fed's 2% target, policymakers should consider suspending rate increases once their benchmark rate has been neutral.
This approach may not seem controversial, but it would be unprecedented in recent history.
Traditionally, to guard against overheating, the Fed has raised rates high enough to curb growth. "If you are neutral but the economy is growing so fast that you do not want to reach your inflation rate target, neutrality is not where you want to be," said the Boston Fed president, Eric Rosengren. He promoted the increase in quarterly rates over the coming year.
Fed Chairman Jerome Powell did not take sides, but in a speech last month at the Central Bank's annual retreat at Jackson Hole, Wyo, he said he could deal with traditional models with more skepticism than some of his colleagues.
He expressed skepticism about the firmness with which policymakers should rely on estimates of long-term unemployment levels and neutral rates that guide traditional thinking. The Fed "sails between the sandbanks … with only a blurred vision of what appears to be changing navigational guides," Powell said.
Powell applauded Fed decisions under Alan Greenspan's presidency in the mid-1990s to challenge models and wait for signs of inflationary pressures before tightening policy.
The need for such a slow strategy, given the low response of inflation to the rise or fall of the workforce in recent years, "is clearer than ever" said Powell.
Financial turmoil abroad is the biggest risk for the Fed's plans. Authorities could delay rate hikes if a stronger dollar would disrupt emerging markets or if tariffs would slow down China, causing massive sales in global markets.
Richard Clarida, the Columbia University economist who was confirmed by the Senate to become vice-president of the Fed, explained that international bonds could make rate hikes more difficult without triggering periods of volatility in the US. other savings.
On the other hand, a pause in rates could be difficult to obtain if managers feel more and more concerned about the potential for dangerous asset bubbles, as a pause could trigger a market recovery.
Fed governor Lael Brainard had highlighted the potential for temporarily stalling stalled rate hikes in a speech at the end of May, but made no reference in a speech on Wednesday. Instead, she said the continuation of rate hikes could be justified "over the next two years".
Write to Nick Timiraos at [email protected]
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