I cannot recall a moment when the gap between what markets expect the US Federal Reserve to do and what the Fed itself has forecast it will do has been as large. Markets predict that the Fed will raise rates only to 1.6 per cent by the end of 2017; the Federal Open Market Committee’s average forecast is 3.5 per cent.
Such a divergence raises the risk of volatility and poses a communications challenge for the Fed. More important, it raises the question of what should guide future policy.
Especially after Friday’s very strong employment report, there can be no doubt that cyclical conditions are normalising. The unemployment rate now is at its postwar average level, and continues to fall. Job openings are above their historic average. Other indicators such as the insured unemployment rate suggest a normal or rapidly normalising economy. All of this taken in isolation would suggest that interest rates should not remain at zero much longer.