The Fed, International Weakness, and the Impotence of Monetary Policy

The Fed decided to keep rates on hold today. More
surprising, they didn’t start laying the groundwork for October. This increases
the odds of a December hike.

The key elements holding the Fed back are international
weakness and stubbornly low inflation.

In the presser, Chair Yellen made it clear that the FOMC
would still like to see further strengthening of the labor market. She
indicated that they had already seen enough labor improvement to meet the
standard that had been looking for until recently, but, in light of increased
global growth concerns, they now feel they need more labor market strength to bolster
our ‘insulation’ from global vagaries.

On inflation, Chair Yellen addressed the
uncertainties regarding the weak link between monetary policy and inflation.
She reiterated the FOMC’s expectation that continued improvement in the labor
market and the fading of transitory commodity price effects would still, ultimately,
allow inflation to get back on a path up toward 2%. 

But, reading between the
lines, she sounded less confident on this point than ever.  And it is not clear if their Plan B is ‘zero
for longer’, or ‘leap of faith’. Watch this space. If inflation doesn’t respond
as the FOMC expects, the bar for labor market strength and calmer international
waters will likely be raised yet further.