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The Market’s Fed Freakout Is Unjustified

Janet Yellen Speaks At Monetary Policy Implementation ConferenceJanet Yellen Speaks At Monetary Policy Implementation Conference
Janet Yellen, chair of the U.S. Federal Reserve, speaks at a monetary policy implementation and transmission conference at the Federal Reserve in Washington, D.C., U.S., on Thursday, Nov. 12, 2015. Photograph by Andrew Harrer—Bloomberg via Getty Images

Stocks took a dive Thursday morning, with the Dow falling more than 1% and the S&P 500 briefly turning negative for the year.

Some analysts are laying the movement at the feet of the Fed, as no less than six Fed officials were slotted to give speeches on Thursday. The problem is that none of these talks, at least as of mid-day, are telling us anything new about Fed thinking. Richmond Fed President Jeffrey Lacker was at a Cato Institute conference where he argued for more hawkish fed policy, but the markets have known that Lacker has wanted to raise rates for more than six months now.

On the other side of the spectrum, Chicago Fed President Charles Evans urged caution on raising rates, and predicted that the federal funds rate will still be below 1% by 2016, much lower than the typical FOMC member.

These speeches give great insight into how individual fed members think. Lacker, for instance, called himself “old-fashioned” in his Cato speech: he sees Fed policy as about controlling inflation through the money supply. While his colleagues might study dynamics like the wealth effect of higher equity and housing prices, or how inflation is sparked by low unemployment, he’s laser-focused on how much money is in the system. As the Fed has created a tremendous amount of bank reserves in the past seven years, and unemployment is below its pre-crisis norm, we should trust that inflation is on the way even if there are no signs of it just yet.

Evans, on the other hand, is mostly concerned with the Fed’s reputation and its ability to communicate with the public. The Fed has set a 2% inflation target (which means that half the time inflation will be actually above that level), and if it doesn’t do everything in its power to hit that target, the public will lose confidence in the central bank. And that loss of confidence could put the United States economy in the same position as Japan’s, where the central bank has been unable to spur higher prices.

New York Fed President William Dudley’s speech was more down the middle, and represented the sort of thinking that Fed Chair Janet Yellen has been communicating in her post-meeting press conferences. He argued that the U.S. economy is picking up steam, and that the labor market is almost tight enough to start producing more significant wage increases. While he pointed out that there are risks to raising rates too soon and too late, “I think it is quite possible that the conditions the Committee has established to begin to normalize monetary policy could soon be satisfied.”

His talk was consistent with what the fed futures market and economists are now expecting: that rates will rise by 25 basis points in December. But both Dudley and Evans stressed that any further tightening would likely be very gradual, because the U.S. economy is still dealing with weakness abroad, a strong dollar, and the lingering effects of the financial crisis.

If all of this sounds pretty consistent with the FOMC’s most recent monetary policy statement, that’s because it is. If investors are indeed getting spooked by statements like Lacker’s, they should realize that there’s no reason to be afraid. He’s been petitioning for tighter policy for some time now, but his views are not held by the majority of the committee. And while it’s likely that we’ll see higher rates come December, the majority of FOMC members are convinced for the time being that the path from 25 basis points to a fed funds rate over 3% will be a long and winding one.