Fed: Jackson Hole Postscript

Published on August 31, 2015

A few quick takeaways on the Federal Reserve’s likely near policy path in the aftermath of the heavy messaging from officials at this weekend’s Jackson Hole conference: 


*** The Federal Open Market Committee remains determined to start “policy normalization” before year-end, and barring a downside shock in the coming weeks, our sense of the Committee majority consensus still tilts the odds modestly to a first rate hike at the September 16-17 meeting. In that regard, Vice Chairman Stanley Fischer went out of his way at Jackson Hole to keep that option very much on the table (see SGH 8/27/15, “Fed – Cautiously Repositioning”). ***


*** Caution to take more time to assess China uncertainty or the ongoing low inflation risks could still push the decision back to either a “live” October meeting or the December meeting with a well telegraphed move to neutralize year-end illiquidity concerns. How the market trades this week and especially how it reacts to what is expected to be a healthy Non-Farm Payroll on Friday will also be critical factors in driving the rate hike timing. ***


A “Reasonable Confidence”


** The persistence of low inflation is something Fed officials will keep an eye on, but as strongly indicated by Vice Chairman Stanley Fischer in his prepared remarks on Saturday, a Committee majority still seems to be “reasonably confident” inflation will begin rising back to 2% in due course.


** Their faith is primarily built around an assumption the labor market healing puts a floor under any sustained falls in services sector inflation and that the downward pressures on goods inflation in lower oil prices and the strong dollar — however much the latter’s effects may linger — are transitory factors relative to the underlying fundamentals of slowly rising inflation.


** Crucially, the “sooner” argument for a hike also still stands: the cost of a policy error in moving too early is easily corrected through an extended pause or moving even more gradually, while the potential cost of moving too late is considered too high in potentially being forced to move rates rapidly if data comes in stronger than expected and the markets re-price violently on the belief Fed is not only behind the proverbial curve but especially so in starting from a zero rate.


Tactical Calculations


** The decision on when to hike this year is also largely tactical at this point, that is, which of the three remaining FOMC meetings to start the long-awaited policy normalization is likely to entail the least amount of market dislocation?


** The FOMC does expect market volatility to surround a first rate hike — there will be some road debris in the rearview mirror — and is determined not to let market dislocations impair its timing. But it will nevertheless be very reluctant to undertake a first rate hike amid excess volatility.


** How the market trades this week, and especially after the NFP print on Friday, will thus provide important price discovery signals to the Fed on how violently the market might react to a first rate hike, be it September or later.


** In that context, by previewing the main takeaways of his Saturday speech in the interview to CNBC on Friday morning — the sort of market-relevant questions that should have been asked but weren’t in the August Bloomberg TV interview — Fischer gave the market the rest of the day and weekend to digest his modestly more hawkish messaging through this week after the soothing accent New York Fed President Bill Dudley had put on the “less compelling” case for a September rate hike.

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