The Fed’s ‘road map’ to higher interest rates

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The Federal Reserve made clear Wednesday that it isn’t planning to raise short-term interest rates soon.

But the central bank also got more specific about the conditions that would spur it to lift its key rate from the current zero-to-0.25% range.

Here’s how the critical paragraph in the Fed’s post-meeting statement reads:

The bolded type is what was added to that paragraph since the Fed’s last meeting on Sept. 23.

‘In citing these three conditions, the Federal Reserve has provided a road map by which market participants can gauge with greater precision the evolution of monetary policy, in particular the exit strategy for the Fed’s current stance,’ Tony Crescenzi, a bond market strategist at Pimco in Newport Beach, wrote in a note to clients.

‘This will make the implementation of the Fed’s exit strategy more a process than event,’ Crescenzi said. ‘It will also give the Fed an ‘out’ because incoming data related to the three conditions mentioned will take on greater weight than the Fed’s own words, allowing the Fed to simply rubberstamp the conclusions drawn by market participants regarding the incoming data.’

The first condition mentioned -- ‘resource utilization’ -- could apply to both labor and factory capacity, both of which are severely underutilized at the moment. No debate there. Even if the economy keeps expanding, the Fed is saying that it wants to see labor and industrial slack taken up before it will think about tightening credit.

To measure whether inflation trends are ‘subdued,’ the Fed presumably would rely on the government’s major inflation gauges, including the consumer price index and the so-called personal consumption expenditures price index. The year-over-year gains in the ‘core’ indexes of those gauges were 1.5% and 1.3%, respectively, in September, which in both cases would qualify as ‘subdued.’

To measure whether inflation expectations are ‘stable,’ the Fed could look at future price increases implied by interest rates on Treasury inflation-protected bonds, and at trends in gold prices and the dollar.

Crescenzi noted that the Fed’s statement specifically referred to longer-term inflation expectations as being ‘stable’ at the moment.

But are they?

‘It is intriguing that the Fed would label inflation expectations ‘stable’ when the amount of inflation expectations embedded in 10-year inflation-protected Treasuries reached its highest point of the year -- 2.14%, indicating that 10-year inflation-protected Treasuries are priced for the consumer price index to increase at a 2.14% [annualized] rate over the next 10 years,’ Crescenzi said.

Gold, hitting record highs this week, also could be signaling rising inflation expectations. But gold’s new bull run also could be pointing to something more visceral -- increased distrust of all paper currencies -- rather than heightened concern about inflation.

-- Tom Petruno