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The Fed is not fond of being cast as the world's central banker. After all, excessive focus on the global backdrop can make policy sub-optimal from a domestic perspective. However, the other extreme of policy isolationism is not an option.
The FOMC acknowledges that "readings on financial and international developments" matter for the domestic outlook. Matching the domestic and external pictures is not always challenging, but it is now. The US economy appears to be humming along, while markets have been wobbling on fears of a global slowdown. Judging the extent to which it should heed these market concerns will be an important near-term decision for the FOMC.
New York Fed President William Dudley discussed the challenge this week. He noted international developments have increased downside risks to US growth, and that upcoming data releases are unlikely to reflect the impact of the latest tightening of financial conditions. This suggests that, for now, the Fed will be exercising a heavy dose of judgment on the effects of global threats.
"In this note, we parcel the drivers of the latest market developments and draw implications for the Fed. In particular, we simulate the Fed's FRB/US model to gauge the impact of tighter financial conditions on the US economy. We find that in a scenario of a moderate global slowdown, some dollar appreciation and contained corrections in equity markets, the Fed can still plough on with lift-off", says BofA Merrill Lynch.
