In a note to clients, Lew Alexander at Nomura writes that the Fed is likely to make "significant changes" to its forward guidance.
Forward guidance refers to the language the Fed uses when it tells the public its plans for monetary policy.
"At a minimum, we expect the FOMC to add language that stresses the 'data dependence' of future interest rate decisions," Alexander writes. "We expect the FOMC to continue to state that the adjustment of interest rates, when it comes, will be 'balanced' and that it expects interest rates to converge to normal levels more slowly than employment and inflation. But in light of sustained improvement in labor market performance, and the inherent complexities in assessing their state, we expect the FOMC to drop its assessment that 'lift-off' is still a 'considerable time' away."
Dropping the "considerable time" language would be a big change for the Fed.
The Fed has signaled that it is on pace to conclude this program in October, which then starts the countdown to the Fed's first interest rate increase. In recent monetary policy statements, the Fed has said that, "it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends."
Back in March, the market freaked out when Yellen put a number on this "considerable time."
At her post-FOMC meeting press conference in March, Yellen said rates could rise "something on the order of six months" after the end of the Fed's asset purchases. In her June press conference, however, Yellen did not give a six months timeframe again, and stuck with the Fed's "considerable time" language instead.
In his note, Alexander gives four reasons for why this language could change in September, and why "considerable time" may no longer be part of the Fed's forward guidance lexicon:
- Our interpretation of Yellen's Jackson Hole speech. (Nomura said Yellen's Jackson Hole speech acknowledged that the labor market has improved enough that for the first time since the financial crisis, the priorities for monetary policy have changed.)
- The tension around this issue within the FOMC that was evident in the July minutes.
- The fact that interest rates remain stable and financial conditions are broadly supportive for growth.
- Our expectation that the economy will continue to expand at a healthy pace and labor market performance will continue to improve.
Alexander still sees the first rate interest rate hike occurring with the June 2015 FOMC meeting, but notes that, "recent developments in U.S. monetary policy have shifted the risk around our call forward."
So expect a change when the Fed announces its latest monetary policy decision on September 17, and expect that change to have people wondering if rate hikes are coming sooner rather than later.
This chart from Nomura shows how market expectations for interest rates are well below the FOMC's latest projections, indicating that a more hawkish tone from the Fed could spook the market.
Nomura