Fed normalization - the new buzz

The new buzz in monetary policy is Fed normalization. Of course, we still are trying to define it before we implement it. We need to go back to basics.

Four conditions are necessary for the Fed to raise interest rates:

1.Above trend growth - the first quarter numbers were negative
2. Tightening of the labor markets - improvement but not close to what Chairman Yellen wants
3. Rise in inflation - still below 2% with little upside
4. Money velocity stabilization - there has not been any

For each of these conditions the answer is, NO for a Fed increase. It is not on the table.

The real issue is with the comments from NYFed president Dudley. He stated that we may come off the zero interest rate bound before stopping the bond reinvestment programs. The Fed wants to raise rates in order the get some flexibility while still holding a large balance sheet. This suggests that we could see a rate increase sooner than expected earlier. It just means that rates could rise while the Fed holds its current huge balance sheet. This is something that the market should watch closer.