For the 54th meeting in a row, the Federal Reserve Open Market Committee decided to leave the target for the fed funds rate at 0% to 0.25%, citing “recent global economic and financial developments [that] may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.” While acknowledging that “the labor market continued to improve, with solid job gains and declining unemployment,” the statement nonetheless noted that “inflation has continued to run below the Committee’s longer-run objective.”

We’ve noted before that, whereas the continued improvement in the labor market allows the Fed to consider raising interest rates, the absence of inflationary pressure does not require it to do so. Today’s decision implies that the Fed remains more concerned about the deflationary implications of global developments than overheating in the labor market. The word cloud on the next page – generated based on the frequency with which words appear in the statement – graphically illustrates how the Fed is more focused on inflation (or the lack thereof) than an improving job market.

Today’s (non-)decision naturally extends the speculation of when the Fed will begin to move toward a more normal monetary policy. Thirteen of 17 participants on the Federal Open Market Committee believe that the first rate hike will take place in 2015. Three expect the first increase in 2016, and one participant believes that a rate hike won’t be appropriate until 2017. For the first time this year there was a dissenting vote on today’s decision, as Jeffrey M. Lacker of the Richmond Fed preferred to see the fed funds rate rise to 25 basis points.

The Open Market Committee next meets on October 28, with one further meeting before the end of the year, scheduled for December 16. There is no press conference planned for the October meeting, but Chairwoman Janet L. Yellen confirmed today that the absence of a press conference would not preclude a policy change at that meeting.

We believe that the continued delay in implementing a first step toward more normal monetary policy raises four risks:

  1. Continuing to hold rates at zero signals that the Fed remains worried about the durability of the economic cycle. At some point, sentiment may begin to shift as investors wonder what the Fed knows that the rest of us don’t.

  2. Allowing equity market fluctuations to influence policy creates the illusion of a Yellen put. The Fed claims to be “data dependent” in its policy discussions, but are investor sentiment and market volatility part of the data set on which it depends? If so, that runs the risk of a vicious feedback loop in which the fear of a rate increase creates precisely the market environment that precludes the increase from taking place.

  3. Delaying the initiation of higher rates may accelerate the pace of increases when they do eventually start. At present, the lack of inflation would allow the Fed to raise rates at a gradual pace, but that luxury may disappear if or when inflationary pressure becomes more apparent in the future.

  4. The Fed remains unable to rely on interest rate policy in the event of an economic downturn. With interest rates already at zero, the Fed’s policy options are limited should the economy weaken. Other than some variation of further quantitative easing (that is, using the balance sheet to acquire assets and push market rates lower), the Fed can’t easily push policy rates lower than they already are.

So the guessing game continues. Our investment strategies remain focused on fundamental analysis and the identification of value, but lingering uncertainty about the path of monetary policy could easily prolong the sort of price volatility we’ve experienced over the past several weeks.