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05 19 2016 | by Victor Xing | Capital Markets

President Dudley and financial conditions

After delivering his opening remarks on the New York Fed’s monthly economic Snapshot, President Dudley acknowledged the “pretty strong sense” among FOMC participants that the market was not putting in sufficient probability of tightening in June or July.  He added that he was “quite pleased” to see the probability move up following the release of April FOMC minutes, in-line with warnings by Boston Fed President Rosengren and Atlanta Fed President Lockhart on market “pessimism.”

In his view, the median projection for the funds rate in the March SEP, which showed 2 tightening in 2016, was a “reasonable expectation.”

President Dudley
New York Fed President Dudley, speaking at the Economic Press Briefing on the U.S. Economy in a Snapshot, Federal Reserve Bank of New York, New York City

Financial conditions

Dudley explained to the press that one reason to tighten monetary policy is to tighten financial conditions, which were more loose than policymakers’ expectations:

  • Tighten policy because the current policy path is “not sustainable”
    • Near NAIRU labor market conditions
  • Some tightening of financial conditions is appropriate (and it is the purpose)
  • The degree which financial conditions would tighten is uncertain, and policymakers will react accordingly
    • Monetary policy works through financial conditions, and they “absolutely do matter”
    • Monetary policy generates a set of financial conditions, which generates growth path consistent with the Fed’s dual mandate
    • If financial conditions do not tighten despite policy tightening, the Fed would have to tighten more; conversely, excessive tightening of FCI means the Fed would need to do less

Factors on “Brexit”

Dudley does not see “Brexit” triggering a binary outcome on Fed’s rate path.  Instead of “go or wait,” he sees an interplay between three factors:

  • The probability of a leave vote
  • Likely impacts of a leave vote
  • Context of economic and financial conditions at the time

Thus, if financial conditions tightens more than expected or economic conditions worsen, a higher probability of “Brexit” would affect policymakers’ outlook and further push out the subsequent rate hike.  Conversely, if the U.S. economic conditions beat expectations (which would normally pull toward policy normalization) while financial conditions remain largely unchanged, the Fed may chose to look through “Brexit” risks.

Finally, President Dudley emphasized that risks of “Brexit” did not change, but its relevancy did given the potential timing of a policy decision.

Additional risk factors

President Dudley echoed the April FOMC statement and sections of the minutes that risk factors that dented market sentiment during Q1 have “subsided”

  • Oil prices have recovered to “a degree”
  • Market participants are more comfortable with China’s currency regime
  • The concerns have “abated,” but “not gone” nor to say “they couldn’t come back”


Next article05 18 2016 | by Victor Xing | Central Banks

April FOMC minutes: signaling for June