Prior Week Summary
In a highly anticipated speech at the Jackson Hole symposium, Janet Yellen made a strong case for the need to tighten monetary policy in the short run. The chairwoman pointed to expanding economic activity, led by growth in household spending, as sufficient to generate further improvements in the labor markets. The Fed chair argued that the dynamics weighing on the inflation target reflect the transitory effects of earlier declines in energy and import prices. The committee expects moderate growth in real GDP, continued strength in the labor markets, and an increase in the inflation rate towards the 2% target over the course of the next few years.
The media and market commentaries focused heavily on the following statement from Janet Yellen which served to increase the market implied probability of a hike, potentially as soon as the September meeting.
“Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months. Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee’s outlook.”
However, the market tended not to read or react to the following set of statements that seem, to this reader, to characterize the very high level of uncertainty the Fed has in their ability to forecast macroeconomic trends in the current environment as well as the market’s growing distrust in the Committee’s forward guidance.
“Our ability to predict how the federal funds rate will evolve over time is quite limited…and the level of short-term interest rates consistent with the dual mandate varies over time in response to shifts in underlying economic conditions that are often evident only in hindsight.”
The chairwoman then referenced a chart in her printed materials which highlighted the fact that the Fed can only say there is a 70% probability the fed funds rate will range between 0% and 3.25% by the end of next year and range between 0% and 4.5% by the end of 2018. The wide range provided by the chairwoman, appears to have limited the market’s reaction to the first statement, and to this reader, the potentially efficacy of future forward guidance. As of this writing, the market is placing slightly less than coin flip odds for a hike at the September meeting.
The Look Forward
A relatively busy week in front of the Labor Day holiday in the U.S. with updated releases on personal incomes, manufacturing activity, home prices, and the labor markets.