Fed: Desperately Seeking Clarity

Published on August 25, 2016

How it seems a lifetime ago that the Federal Reserve went into this year charting some four rate hikes and yet, now nearly some eight months later, the debate is whether there will be even a single rate hike, if ever.

Little wonder then there is such a craving for clarity as the market awaits amid an eerie calm for Chair Janet Yellen’s speech tomorrow morning in Jackson Hole.

*** The desire for clarity aside, we think Chair Yellen is unlikely to telegraph explicit guidance on September. But we still think she may indicate that, barring a southern turn in the data, a rate hike would be appropriate by year-end, reflecting what in any case we continue to believe is the consensus of a solid majority of the Federal Open Market Committee (see SGH 7/12/16, “Fed: The Emerging Post-NFP Consensus”). ***

*** We likewise think a second rate hike this year is more likely than not to be followed by an extended rate pause, to give the FOMC time to assess the rate impact on the real economy and to weigh the likelihood of a major fiscal policy push under a new president and Congress. On that note, above all we will be curious to see whether and to what extent fiscal policy enters into the debate over new monetary policy frameworks. ***

*** But Chair Yellen’s keynote address as well as the academic papers and conference discussions will otherwise revolve around much longer term monetary policy issues in assessing the Fed’s current policy framework, forecasting assumptions, transmission channels, and the “tool kit.” While the discussions will look into the merits of new or a modified policy framework and instruments, the debate is about an evolution, not a sweeping change any time soon. ***

“The Monetary Policy Tool Kit”

Chair Yellen’s speech, “The Federal Reserve’s Monetary Policy Toolkit,” is the keynote address, which traditionally sets up the key themes and issues to the academic papers and panel discussion on a conference about “Building More Resilient Policy Frameworks,” which is to say, monetary policy for much further down the road.

As Yellen tends to be thorough, even exhaustively detailed, in her speeches, we would not be surprised to hear her review the broad sweep of the policies undertaken and instruments used since the crisis and moving towards what potential policies and instruments could be considered in the case of a downside — or upside — shock to the forecast.

That would start with traditional policy tools in small-scale open market operations and discount window lending through the crisis-management liquidity facilities, the efficacy of the new overnight reverse repo, as well as the various stages of large scale asset purchases finally perfected (in the minds of many Fed officials) in QE3’s open-ended bond regime and the 6.5%/2.5% Numerical Thresholds.

She is likewise near certain to delve further into the issues of a future policy framework that adapts monetary policy implementation to ensuring financial stability, the liquidity impact of the new regulatory structures, and perhaps what can be done to deal with the demand for safe assets. And we will be curious to see if she advances some of the thinking about the future overall size and composition of the Fed’s balance sheet as well as the most likely policy options in the event of another downturn.

San Francisco Fed President John Williams threw into the mix for consideration a higher 3% inflation target. Yellen will no doubt express her concern over the need for the Fed to assess its options but she is equally unlikely to endorse any one proposal just yet, and we would be surprised is she indicated enthusiasm for a higher inflation target. A tolerance for an “accidental” overshoot of the current 2% target yes, but an engineered overshoot much less a formal adoption of a 3% or higher inflation target is not in the cards any time soon.

At the same time, like most of her FOMC colleagues, Chair Yellen is resigned to a far flatter, even more gradual upward trajectory with a terminal point that is likely to fall to no more than a nominal 3% by 2018 or 2019. In the June meeting press conference, Yellen all but conceded to Harvard University Larry Summers and his drumbeat on the implications of a secular stagnation in a persistently low real neutral rate.

But as we wrote previously (SGH 8/17/16, “Fed: Jackson Hole Prologue”), any discussion whether in Jackson Hole or future speeches on the new sense of where the neutral rate lies and what it means for the longer trajectory of rates does not dictate or limit the Fed’s near term rate move or its timing.

And when Yellen is so methodically careful by nature and instinct, it is hard to imagine her tossing out the current framework any time soon; tweaks to the parameters, layering in a new equation or two to account, factoring in more for the dollar’s role as a transmission channel for certain, but a sweeping change to a new revolutionary framework just doesn’t seem likely any time soon.

The Likely Shape of any Near Policy Signal

All that is to say Yellen will be previewing big subjects, all for down the road, meaning she will need to go out of her way to weave in a near term policy take. And if she does — and we sure hope she does to avoid a major market disappointment — it would frankly be more to her style to avoid getting too specific about the odds on the timing to a rate hike.

And in any case, when she has done so on those rare occasions in the past, it has tended to come as an affirmation of a Committee consensus already worked out in the prior FOMC meeting — which most clearly was not the case in July, judging by the Minutes.

With that in mind, we think Chair Yellen may in fact leave it even vaguer, noting her confidence about the recovery being very near anyone’e notion of full employment, and saying something along the lines of a rate hike being appropriate “if labor market data continues to improve” — i.e. the September 2 Non-Farm Payroll number looms large — and thus leaving it to our imagination what it might suggest about September and with even more certainty, about December.

So if she and the rest of her Committee colleagues maintain their messaging discipline in doing their best to avoid date specific guidance — good luck with that — she will work to keep the rate hike option on the table, but offering no definite signal on its timing.

But by whatever phrasing she and her staff settle on in terms of how to frame the near term rate path — it probably won’t be “in the coming months” after the May messsaging misfire — we nevertheless believe the market will draw from Jackson Hole by its end a sense of high odds for a rate hike by year-end with a September move possible and December more certain. 

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