As an extraordinarily mild winter here in the northeast winds down and transitions to spring, the financial markets seem to have regained their footing. It’s a perfect time for me to indulge a bit.

I have to admit I am at a loss as to what the Federal Reserve (Fed) is looking to do.

Based on Fed Chair Janet Yellen’s recent testimony before Congress and statements from Vice Chair Stanley Fischer – the standard bearer of the Fed’s Philips Curve doctrine, which posits that there is an inverse relationship between inflation and unemployment – you would be excused if you thought the odds of Fed tightening in the not-too-distant future are actually increasing.

You see, the data flow of late has been shaking off the slowdown of the 4Q2015 and getting a bit peppy, as the following charts illustrate (Exhibits 1-3).

Federal Reserve Risk Outlook Is Changing: Exhibit 1- OppenheimerFunds

Federal Reserve Risk Outlook Is Changing: Exhibit 2- OppenheimerFunds

Federal Reserve Risk Outlook Is Changing: Exhibit 3- OppenheimerFunds

All of the data are looking up. If you were following Yellen, you would expect, based on these numbers, that even if the Fed passes on another rate hike in March, it will tee things up for June. That teeing up would require Fed policymakers to, at a minimum, reinsert a balance of risk statement in their communique or even go as far as shifting their balance of risks statement to the upside.

Balance of Risks Tilting … to the Downside?

But contrary to such expectations, the exact opposite seems to be happening.

First, in a speech on Feb. 26, Fed Board of Governors member Lael Brainard, who also sits on the policymaking Federal Open Market Committee (FOMC), argued that in the current global economic environment, policy divergence is less likely.

She stated that:

“Beginning in 2014, we saw confident predictions of a coming strong divergence in monetary policy among the major economies. To date, there has been less policy divergence in reality than had been predicted. This observation raises the question of whether there may be limits on policy divergence in current circumstances. Such limits might reflect common forces buffeting economies around the world or the powerful transmission of shocks across borders through exchange rate and other financial channels that may have the effect of front-running monetary policy adjustments in the vicinity of the zero lower bound. Put differently, predictions that U.S. monetary policy would chart a notably divergent path have been tempered by powerful crosscurrents from abroad.1 (Emphasis added.)

Then, on Feb. 29, New York Fed President and FOMC member William Dudley gave a speech in China and had this to say:

“Now, putting these inputs and my judgment together, I see the uncertainties around my forecast to be greater than the typical levels of the past. This assessment reflects the divergent economic signals I highlighted earlier, and is consistent with the turbulence we have seen in global financial markets. At this moment, I judge that the balance of risks to my growth and inflation outlooks may be starting to tilt slightly to the downside. The recent tightening of financial market conditions could have a greater negative impact on the U.S. economy should this tightening prove persistent and the continuing decline in energy and commodity prices may signal greater and more persistent disinflationary pressures in the global economy than I currently anticipate. I am closely monitoring global economic and financial market developments to assess their implications for my outlook and the balance of risks.”2


U.S. manufacturing – the epicenter of the current domestic slowdown – is actually bottoming out, inflation is picking up, employment remains strong, and consumer spending is robust. But the effective spokesperson for the Fed between meetings – Dudley himself – is saying that the balance of risks is tilting to the downside.

Is the Fed capitulating due to the global, as opposed to just the U.S. centric, view?

In my view, this is quite profound. I fully agree with Dudley’s judgment. And if my speculation is correct and the Fed is reorienting its thinking based on the global outlook, there may be hope for the global economy and global markets.

Maybe, just maybe, January and February turn out to be the only bad months of the year for investors. We shall see.

Follow @krishnamemani for more news and commentary.

1 Remarks by Federal Reserve Governor Lael Brainard at the 2016 U.S. Monetary Policy Forum, New York, NY, 2/26/16.

2 Remarks by New York Federal Reserve President William C. Dudley at the People’s Bank of China-Federal Reserve Bank of New York Joint Symposium, Hangzhou, Zhejiang, China, 2/29/16.