Fed: “Greater Gradualism”

Published on March 29, 2016

Federal Reserve Chair Janet Yellen’s luncheon speech before the Economic Club of New York earlier today was by most accounts as dovish as they come, and if anything else, it was noteworthy for a Chair’s speech in that she seemed to cede little to her Federal Open Market Committee colleagues who last week adopted much more hawkish stances, even putting an April rate hike on the table.

*** Chair Yellen all but scolded her colleagues on their more hawkish remarks about April, and she went some way to discounting the odds on a June rate hike. While the labor market is still set to tighten with growth looking to hold steady above trend, she put the accent of her speech on the uncertainty in global developments and risks, which are adding “significantly” to a “greater gradualism” on the pace of policy normalization from here. ***

*** That said, unless the data turn unexpectedly soft from here, we still think a June rate hike should not be ruled out. A summer move followed by an extended pause until December, for instance, may come to be a credible compromise to maintain a reasonably firm Committee policy consensus. What’s more, in some sense, a calmer market and global outlook will make it that much easier for the Fed to hike as soon as June. ***

Chair Yellen made three points that stood out for us.

The first was how much weight she put on foreign factors as a “significant” influence on US monetary policy. She noted as she did in the March meeting press conference that the outlook had not really changed all that much between March and December, but that the rate path was adjusted lower in order to keep the economy on course with the growth projections.

And that needed adjustment was not so much a change in the reaction function as it was a more straightforward pre-emptive move to get in front of a potentially negative global impact on the outlook. She also made a point of singling out China, noting the pace of global growth was “importantly influenced by developments in China,” and she wondered aloud how smoothly its transition to domestic-driven growth would be, and she also made note of further potential financial disruptions in the market during that transition.

The second point we though worth highlighting was that while Chair Yellen did offer a slight concession to the “first stirrings” of inflation concerns of many of her colleagues, she otherwise pressed pretty hard that despite the recent uptick in higher core inflation, any near term sustained rise in core inflation is nevertheless unlikely. “It is too early to tell if this recent faster pace will prove durable,” she said with a rhetorical shrug. As we noted in our report yesterday (SGH 3/28/16, “Fed: Waiting for Chair Yellen”), however, we still believe the debate over how the dynamics of the inflation process play out this year will invariably be the main driver to the rate decisions and policy messaging in the months ahead.

And finally, the third and perhaps most fascinating point Chair Yellen stressed repeatedly was an apparent newfound appreciation of the market pricing, essentially doing much of the Fed’s work to keep the recovery on track.

To be sure, the March revisions to the rate plot were essentially a correction to a mistaken signal sent in the December rate plot — it is why she so fully embraced the rate plots this time — but today she made the point several times to practically thank the market for ignoring the Fed’s previous messaging; its far easier and dovish rate pricing just may have limited any of the damage the Fed would have inflicted on the outlook if its policy signals were taken seriously.

That has to be a first.

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