FOMC expected to hold on interest rates, split may be emerging on future hikes in 2016

As the Federal Open Market Committee sits down Tuesday (July 26) to consider again whether to raise the federal funds rates, St. Louis Fed President James Bullard and other committee members are increasingly speaking out about the direction of U.S. monetary policy under Chair Janet Yellen.

The nation’s monetary policy is made by FOMC which consists of the members of the Board of Governors of the Federal Reserve System and five Reserve Bank presidents. The July meeting is one of eight regular conferences scheduled for this year, and is seen by some as pivotal as they debate over future rate hikes in the near term.

Although most analysts believe Yellen will announce after the FOMC meeting on Wednesday that rates will remain at 0.25% to 0.5%, many experts will be looking for signs that a split is emerging on the body between board members who want to take action and tighten policy and others who advocate caution in support of slow-growing U.S. and shaky international markets.

At the Fed’s March meeting, Kansas City Fed President and CEO Esther George decided to challenge the current policy, saying she preferred to raise the target range for the federal funds rate to 0.5% to 0.75%. Fed Vice Chairman William Dudley, St. Louis Fed President James Bullard and the other members of the FOMC voted with Yellen to hold interest rates steady.

Although George voted with the majority again to maintain the accommodative policy, some economic watchers believe there is a growing divide among committee members as the U.S. economy has gained strength and expanded in the first half of 2016.

“The minutes from the FOMC’s March meeting reflect a growing gap in the performance and outlook of the U.S. economy compared to the global economy. While the committee managed to show a relatively united front in taking a wait-and-see approach to emerging risks in the global outlook, that may not be the case later in the year,” National Association of Federal Credit Unions (NAFCU) Chief Economist Curt Long said.

Long added: “If the domestic economy continues to advance at a moderate pace while global risks remain, we may see sharper disagreements between the hawks and doves on the appropriate monetary policy response later in the year.”

While hawkish policymakers like George are advocating for immediate rate hikes, St. Louis Fed Chief James Bullard has shifted to a more flexible policy view, saying the U.S. has entered an era of low growth, low inflation and low employment. In support of his policy switch, the Eighth District Fed Chief said the expansive district that includes Arkansas is changing its characterization of the U.S. macroeconomic and monetary policy outlook.

An older narrative that the Eighth District has been using since the financial crisis ended has now likely outlived its usefulness, and so it is being replaced by a new narrative, Bullard said in a white paper released on June 17. The upshot is that the new approach delivers a very simple forecast of U.S. macroeconomic outcomes over the next 2-1/2 years, meaning only one interest rate increase is necessary during that period. Over this horizon, the forecast is for real output growth of 2%, an unemployment rate of 4.7%, and trimmed-mean inflation of 2%.

“The hallmark of the new narrative is to think of medium- and longer-term macroeconomic outcomes in terms of regimes. The concept of a single, long-run steady state to which the economy is converging is abandoned, and is replaced by a set of possible regimes that the economy may visit,” Bullard said.

Besides George and possibly Bullard, FOMC members Loretta Mester, president and CEO of the Federal Reserve Bank of Cleveland, and Fed Board Governor Stanley Fischer have also expressed a desire to raise interest rates in the near term.

In a speech on July 13 at a global financial stability conference in Sydney, Australia, Mester said FOMC members were right in June to delay raising interest rates due to the United Kingdom’s exit from the European Union. She also said any rate hikes should be gradual, but added there is also inherent risk in waiting too long to adjust policy as the U.S. economy continues to expand.

“As I said, I believe that the progress in labor markets has been good and will continue, and I view the inflation data as supportive of a gradual return to target. Now, some might argue that in an abundance of caution, we should wait for clarity on these issues, and I agree that there are risks to acting too soon,” Mester said.

However, the Cleveland Fed Chief added: “But there are also risks to forestalling rate increases for too long when we are continuing to make cumulative progress on our policy goals. Waiting too long increases risks to financial stability and raises the chance that we would have to move more aggressively in the future, which poses its own set of risks to the outlook.”

Unlike recent FOMC meetings, Yellen will not hold a press conference with reporters following Wednesday’s meeting and the committee will not release an update of economic projections. The next FOMC meeting is not scheduled until Sept. 20. The final two 2016 meetings for U.S. monetary policymakers will take place in early November and mid-December.