If there was ever an opportunity to reset market expectations on the Federal Reserve’s near term reaction function, it would be Federal Reserve Chair Janet Yellen’s highly anticipated speech later today at the University of Massachusetts at Amherst on “Inflation Dynamics and Monetary Policy.”
Since that was the subject of the recent Federal Reserve Bank of Kansas City conference in Jackson Hole, perhaps this is the speech she would have given in August if she had not skipped the event this year, albeit one assumes, with a few tweaks to address the uncertainties rattling the markets ever since last week’s dovish Federal Open Market Committee statement and the equally dovish tone of Chair Yellen’s press remarks.
So while awaiting the speech (and watching the address by Pope Francis before a joint session of Congress), here are three points:
** We do not expect a regime shift or any substantial changes in the thrust of her prior views that frames the inflation process and outlook within slack-based Phillips Curve assumptions: as long as growth and the labor market gains continue, core inflation will steadily rise from its current “sticky” lows towards mandate-consistent levels, and that this is the more fundamental domestic driver to prices than the transitory international downward price pressures that will fade from the data in time. Her remarks are likely to still point to a start to policy normalization this year, probably the FOMC’s December meeting.
** While we are unsure if she will address last week’s FOMC meeting directly, it is our sense the reasons behind the close-call rate decision were risk management prudence in light of the international downside risks, and the desire to reset the messaging in the run up to a rate hike, both to temper elevated volatility in what would have been taken as a validation of the tightening in financial conditions and to counter the secular stagnation themes that seem to dominate market pricing. There was also, we suspect, a due deference to the Chair, who is likely to have advised a pass on a rate hike.
** So while we think Chair Yellen will seek to portray a rate hike before year-end as the base case scenario in her speech, finding the right balance will be just as tricky as it was in last week’s presser, where she was taken as more dovish in manner and tone than anything she said. Any acknowledgement of the international growth and deflationary risks will be taken as dovish, simply because it will dial back to the “new” information in last week’s statement. Most of all, Chair Yellen will have to push hard against the secular stagnation arguments currently driving market expectations and pricing if a low liquidity mid-December rate hike is to be credibly on the table.