How The Fed Boxed Itself In

In yesterday's FOMC minutes, the Fed laid out three conditions that must be met in order for it to consider the first tightening.

The minutes from yesterday’s Federal Open Market Committee (FOMC) meeting reveal nothing new. The Fed shifted gears to low last month. It does not have an idea when or if the first tightening will come, and its members are tremendously sensitive to markets. In theory, the Fed is supposed to consider several broad measures of the economy and inflation in its decision-making, but this Fed is more focused on several broad markets.

The Fed laid out the following three conditions that must be met for it to consider the first tightening: improving job market, stable price of oil, and a leveling off of the dollar.

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Two of the three pillars are markets that are controlled by big traders with short-term focuses running leverage positions. The Fed didn’t specify what levels were acceptable, but because we know its members panicked in the middle of March, we have a good idea. The Fed wants to see oil trade steadily near $50, and it doesn’t want to see the dollar soar again and threaten parity with the euro. If jobs gain 300,000 a month and the unemployment rate falls to 4.50%, the Fed will still do nothing if the dollar soars and oil falls below $40.

I understand why oil and the dollar are important and how movements in those have potential economic impacts. But I also understand impacts from those movements tend to be short-term in nature. More than anything, I understand you should not trust these markets to tell you anything but where big money traders are placing bets. But the Fed has charted this course for now, and we have to go along for the ride.

The Fed has boxed itself in by putting the dollar on a pedestal. Anytime we get strong economic data and the Fed starts talking tightening, the dollar will soar. That soaring dollar will then move the Fed away from tightening as long as a leveling off of the dollar remains a requirement, regardless of what the economy dictates. I hope that over the next couple of months Fed officials realize the mistake of tying a market so closely to policy.

Dwight Johnston is the chief economist of the California and Nevada Credit Union Leagues and president of Dwight Johnston Economics. He is the author of a popular commentary site and is a frequent speaker at credit union board planning sessions and industry conferences.

April 9, 2015

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