The Fed decided to hold its fire today, and the bar looks to have been set very high for any hike over the near-term.
This was very dovish in the face of back-to-back quarters of 3 per cent-plus GDP growth, a near-5 per cent jobless rate and a 1.8 per cent core inflation rate – which is a clear "risk on" message for investors; damn the torpedoes, full speed ahead! I differ with the analysts saying this extends the period of policy uncertainty and as such is a negative for asset markets - this would be the case if the statement read hawkishly and the future forecasts for growth and inflation were not trimmed.
What really changed in the press statement (keeping in mind that business capital spending and the labour market tone were both actually upgraded!) was the downbeat view on the global economy and further downgrade of the inflation landscape.
Remember at the June post-meeting press conference, Janet Yellen told us that she needed "convincing evidence" that the dual objectives were being met, especially regarding the inflation target.
"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term." The Fed added for extra measure that it is "monitoring developments abroad."
Not since the Asian crisis of the Fall of 1998 has the Fed been this vocal about global events dominating a rate decision like this.
Note that back in the late 1990s, even after the crisis was long over, and with burgeoning GDP growth and a fully employed economy, it took the Fed 10 months before it began to raise rates.
The key here is that the developments abroad have pushed out the date for the Fed to hit its 2 per cent inflation target even as the labour market tightens further.
In fact, the median FOMC projection for PCE (personal consumption expenditure) inflation in 2015 was shaved to 0.4 per cent from 0.7 per cent (Q4/Q4 basis); to 1.7 per cent from 1.8 per cent for 2016; to 1.9 per cent from 2 per cent in 2017; and introduced a 2 per cent view for 2018 (voila – the Fed hits its target and it magically stays there).
For core inflation, what is key is that 2 per cent is now not seen being achieved until 2018 (from 2017 where it is now seen at 1.9 per cent); and 2016 was taken down to 1.7 per cent from 1.8 per cent.
As for real GDP growth, the downward assessment of global growth based on the events of the past few months showed through in real GDP gains coming down to 2.3 per cent from 2.5 per cent for 2016; to 2.2 per cent from 2.3 per cent for 2017; and then to 2 per cent for 2018 (new forecast).
For this year – a mark-to-market exercise, acknowledging the upward Q2 revision and the overall decent data flow for Q3 – the Fed boosted this year's real growth forecast to 2.1 per cent from 1.9 per cent.
But look at the profile of 2016 to 2018: 2.3 per cent to 2.2 per cent to 2.0 per cent for real GDP growth – no recession, but the economy slows nonetheless.
We never do hit escape velocity in this forecast.
The unemployment rate edges down to 5.0 per cent by the end of this year and then levels off at 4.8 per cent for each of the next three years (from a prior 5.1 per cent forecast for 2016 and 5 per cent for 2017).
So the labour market remains tight but hardly tightens further and there is debate at the Fed as to whether 4.8 per cent is at the "natural rate of unemployment" level that would cause inflation to accelerate – some estimates are closer to 4.5 per cent or even lower.
The number of officials who now see the Fed on hold through the end for 2015 rose to three from two last June (alternatively, the number of FOMC members not calling for a rate hike at the October 27/28 meeting or the December 15/16 meeting, doubled from two to four – that is big, especially if those forecasts include Yellen, Fischer and Dudley).
So the Fed got spooked by events across the ocean and beyond its control, but it is clearly viewing these events as negative exogenous shocks that carries with it downside risks to the domestic economic outlook and delays the time frame for the holy grail of 2 per cent inflation – the Fed's definition of stable prices.
The last time the Fed invoked foreign developments to such an extent (September 1998), it did not hike rates for another 10 months – in fact, at that September 1998 meeting, it cut rates 25 basis points (and then cut again in October and November; one of them was an intermeting easing).
Over that 10 month period, real GDP growth averaged 4½ per cent; the unemployment rate averaged 4½ per cent; and core CPI inflation averaged 2¼ per cent (or 1.3 per cent for the core PCE deflator).
Just in case you need a template, there is an historical precedent for this – and the Fed back then exercised tremendous patience before it resumed its tightening cycle.
This was fertile ground for the "risk on" trade, even as we all thought we were living through troubled and fragile times based on what was happening abroad.
Fear is a far more powerful emotion than greed, but I am tempted to resist the former and embrace the latter, assuming that history is on my side.
So what is an investor to do?
Well, in that period of global angst that spooked the Fed and prevented it from raising rates in the face of a red-hot economy, from September 1998 to June 1999, this is what the financial market landscape looked like:
• S&P 500 rose 29 per cent – and every sector was in the green (Tech, Industrials, and Consumer Discretionary were the leaders; Utilities, Consumer Staples and Health Care the laggards)
• The European Stoxx 600 was up 27 per cent, the U.K's FTSE +24 per cent; and Japan's Nikkei +28 per cent – the global stock markets ripped
• Emerging Market equities jumped 56 per cent – as I said, risk-on
• TSX increased by 19 per cent – also led by Tech and Consumer Discretionary, but the index lagged because commodities were still under pressure
• 10-year U.S. Treasury note yields rose 132 basis points – bear steepener at play
• High-Yield corporate bond yields bond spreads versus Treasury yields narrowed by 78 basis points
• Investment-Grade spreads narrowed by 11 basis
• The CBOE's equity market volatility index (VIX) plunged 35 per cent as volatility collapsed
• The CRB commodity price index declined 11 per cent – the Fed easing did not stop commodity prices from slipping
• The DXY U.S. dollar index rose 7 per cent – a big surprise but despite the rate cuts and "on hold" stance, it was the improving growth outlook that kicked the greenback higher; the Canadian dollar was relatively steady.
David Rosenberg is chief economist with Gluskin Sheff + Associates Inc. and author of the daily economic newsletter Breakfast with Dave.