Fed: Jackson Hole Prologue

Published on August 17, 2016

Key Takeaways:

The FOMC remains set on raising rates before year-end, with a Committee majority leaning towards a rate move as soon as September, provided the data continues on track.

But the far larger driver to market pricing and expectations is the hugely dovish anchoring of the longer run rate trajectory in the Fed’s “capitulation” to a “low R*” policy regime.

Chair Janet Yellen may further open the door to a September rate move in her August 26 Jackson Hole speech that is likely to acknowledge challenges to the Fed’s policy framework but steer shy of a radical break with policy normalization.

August 17, 2016

In his remarks yesterday morning that the Federal Reserve is “getting closer to the time where we should raise rates,” Federal Reserve Bank President Bill Dudley confirmed what should be clear by now, that the Fed remains determined to raise rates before year-end.

But a sense of “seen that movie before” still dominates a skeptical market pricing. That may soon change, however, when we think it likely that Chair Janet Yellen will give a nod to the merits of a near rate hike in her highly anticipated speech a week from this Friday to open the Federal Reserve Bank of Kansas City’s conference in Jackson Hole.

*** Assuming data stay on track, we still believe the FOMC consensus continues to lean towards a rate hike as soon as the September 20-21 meeting, with a rate move certain by December. The timing, in the end, will be largely tactical (SGH 8/5/16, “Fed: The NFP Boost to Rate Hike Odds”), but strategically, this is an FOMC whose majority — including its Chair — is still committed to a “normalization” of rates, however gradual and flattened that path may prove to be. ***

*** The dramatically dovish downshifting underway in the FOMC’s assessment of the economy’s longer run productivity and trend growth is indeed flattening the assumed appropriate rate path towards a significantly lower longer run neutral policy rate. But this dovish anchoring to the rate trajectory should not be taken as a reluctance to nudge rates higher this year or as an abandonment of policy normalization. ***

*** We suspect Chair Yellen will reconcile these two seemingly contrary signals in her August 26 keynote speech at Jackson Hole: an economy nearing full employment should be able to absorb a second rate move that provides insurance against an upside inflation surprise while also keeping FOMC hawks on board with the consensus, and the dovish anchoring of rate expectations lowers potential downside costs in the low likelihood of moving too soon. ***

From the Minutes to Jackson Hole

Dudley’s hawkish remarks yesterday on the near term outlook — echoed by Atlanta’s Dennis Lockhart (and Williams as well, though it did not draw as much attention as his well crafted essay on “Monetary Policy in an Low R* World”) — provide the backdrop to what is likely to be a hawkish tone to the FOMC’s July meeting Minutes to be released later this afternoon.

Lest it be forgotten, the Committee concluded the Brexit-led global risks were diminishing and subsequently downgraded to a monitoring status. We took that to mean a particular eye is being kept on the dollar, which for now is quite compliant, and even easing down a bit. And contrary to signaling a lower likelihood of a rate hike, it in fact makes it that much smoother for the always cautious FOMC to push ahead with a rate rise; ditto for the currently easier financial conditions (save for that technical uptick in Libor rates).

Invariably, even more important for a Yellen-led FOMC are July meeting discussions that concluded the labor market had “strengthened” with household spending “growing strongly” and economy activity “expanding at a moderate rate.” Job gains that were “strong” in June were even stronger in July. We will see what the August NFP print on September 2 brings, but a redux of the early June disappointment seems unlikely. Just in case, there will be an opportunity for a last messaging before the September meeting black-out when Atlanta’s Lockhart speaks on Monday, September 12 at the National Association of Business Economists in Atlanta.

This further tightening in the labor market may draw particular attention in Chair Yellen’s highly anticipated Jackson Hole speech. She had already noted in June that “the economy is now fairly close to the FOMC’s goal of maximum employment,” and so it would not be a stretch to think she might take that a bit further in affirming the economy is effectively at full employment, save for the last of the remaining slack around its outer edges in a labor participation rate that could and should continue to stabilize or even nudge a little higher.

For Yellen, who has placed the labor market at the center of her slack-based view of inflation and monetary policy, it would not be an insignificant moment.

And while we would expect Chair Yellen to religiously shy away from any date-specific references to the Fed’s near term rate outlook, she may nevertheless convey a takeaway from her speech that a further tightening would be warranted if economic and financial conditions continue on their current paths.

To some degree, a narrative is being written that carries the arc of Fed policy from an intended summer rate hike waylaid by the twin uncertainties of a wobble in the jobs outlook and the shock Brexit vote, but which by the July meeting looked back on track and largely reaffirmed in the data since and the Minutes tomorrow. It is a policy messaging track pacing towards a rate hike later this year with the final act set by the NFP print in early September and previewed by Yellen in her Jackson Hole speech next week.

One aside, by the way, was that we were thinking the FOMC would be reviewing their communications strategy at the July meeting (SGH 7/25/16, “Fed: Rebuilding Communications”), which would show up in a mention or even a staff presentation of the communication options in the Minutes.

That would really be interesting in potentially setting the stage for long overdue “evolution” in the Summary of Economic Projections and the rate dot plots in particular. But the fact that none of the Committee members have made any recent mention of any such discussion rather dims the prospects for changes any time soon.

Grand Teton Frameworks

How to communicate policy aside, there will be plenty of discussion about building more robust or resilient monetary policy frameworks in the two and half days of the Jackson Hole discussions in the Grand Tetons late next week.

And we expect the gathered academics and Fed officials to gingerly explore among other things what sort of role the central bank would or could adopt if fiscal policy should finally assume a more pronounced lead role in lifting the economy out of its current low growth, low productivity, low everything paradigm.

But while much is now being made of the Fed’s much belated recognition of the policy implications of a very secular stagnation looking, persistently low equilibrium interest rate, we do think this has more to do with the likely flattening of the projected rate trajectory in the outer years of the forecasting horizon than it does about the probabilities of a near term hike.

Indeed, the so framed “dovish hike” would buy the central bank crucial time to see how fiscal policy plays out next year under a new Administration and Congress; it would likewise give the Fed some running room to weigh the sort of possible changes to its policy framework that will be discussed in Jackson Hole, some of which have already been put on the table in recent weeks by District Presidents Jim Bullard of St. Louis and John Williams of San Francisco.

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