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Bottom line In sharp contrast to last year’s academic snooze-fest, investors were expecting fireworks this morning when Federal Reserve Chair Janet Yellen delivered her maiden keynote speech at the central bank’s annual monetary policy conference in Jackson Hole, Wyoming. But Yellen’s remarks, in our view, struck a very cautious balance in addressing the sometimes conflicting goals of achieving both maximum employment and price stability simultaneously. As a result, we heard nothing out of Jackson Hole to alter our long-standing view that the Fed’s eventual decision to begin to raise interest rates—after it concludes the tapering of its Quantitative Easing (QE) program in October—will be data dependent, with the first hike in the federal funds rate perhaps coming in mid-2015.
Investor anticipation at Jackson Hole was high Last year, for the first time in a quarter century, the chairman of the Federal Reserve (Ben Bernanke) did not attend the Jackson Hole symposium, signaling that he would not be serving a third term as the Fed’s chairman when his term expired in January 2014. This prestigious symposium started by the Kansas City Fed in 1978 routinely draws top central bankers from around the world to discuss important global economic issues, and this year’s topic was labor-market dynamics. At this seminar in 2012, for example, in his keynote speech, Bernanke hinted at his subsequent plans for “Quantitative Easing 3,” which he then launched in September.
The monetary-policy hawks have had the public-opinion megaphone over the course of the summer, with Dallas Fed president Richard Fisher’s op-ed piece in The Wall Street Journal last month, Philadelphia Fed president Charles Plosser’s breakfast speech to investors in New York in June, and recent media interviews by Kansas City Fed president Ester George and Fed vice chair Stanley Fischer. So the expectation was that Yellen, with the eyes of the global investment community watching, would use her high-profile keynote speech to make the case for a more dovish policy balance. But she seemed to strike a more middle-of-the-road stance in her formal remarks, walking the proverbial dual-policy tightrope.
“Pragmatic” balancing act “Monetary policy ultimately must be conducted in a pragmatic manner that relies not on any particular indicator or model, but instead reflects an ongoing assessment of a wide range of information in the context of our ever-evolving understanding of the economy,” Yellen argued.
Specifically, she addressed the cyclical and structural trade-offs that have hurt employment trends over time: the retirement of aging baby boomers, the increase in discouraged workers, leaving work for school enrollment, and workers who have filed for permanent disability, because they were not happy with their job prospects. While some of these trends are permanent, some may eventually reverse when the economy and the labor market strengthens.
“Confronted with an obvious and substantial degree of slack in the labor market and significant risks of slipping into persistent below-target inflation,” she said, in defending the Fed’s aggressive monetary-policy stance over the past six years, “the need for extraordinary accommodation is unambiguous.”
Elephant in the room Ultimately, the key question on everyone’s mind is when the Fed begins to hike interest rates, and upon what triggers should investors focus?
“Tightening monetary policy as soon as inflation moves back toward two percent might prevent labor markets from recovering fully and so would not be consistent with the dual mandate,” she explained. “There is no simple recipe for appropriate policy in this context.”
So it would appear that the Yellen Fed is prepared to err on the side of higher inflation, if the trade-off is stronger labor-market traction.
In search of a one-armed economist Yellen laid out the Fed’s policy conundrum. On the one hand, she said, “if progress in the labor market continues to be more rapid than anticipated, or if inflation moves up more rapidly than anticipated, resulting in faster convergence toward our dual objectives, then increases in the federal funds rate target could come sooner than the Committee currently expects and could be more rapid thereafter.”
But on the other hand, “if economic performance turns out to be disappointing and progress towards our goals proceeds more slowly than we expect, than the future path of interest rates likely would be more accommodative than we currently anticipate,” she countered.
Bottom line, Yellen concluded, “monetary policy is not on a pre-set path.” In other words, there is no change in the fact that this is still a data-dependent decision.
Mixed bag on Fed’s labor dashboard When Yellen assumed the Fed’s chair earlier this year, she took the opportunity to officially change its focus from looking at a single rate of unemployment (U-3) metric to a new employment dashboard, with a variety of key metrics. Some are performing well at present:
But other metrics on the Fed’s employment dashboard are languishing:
Inflation cover But the Fed still has some room to maneuver while waiting for the labor market to recover, because the key inflation metrics that Yellen monitors are still relatively well behaved. In fact, a rise in inflationary pressures earlier this year has recently receded, lending credence to Yellen’s thesis that the spike was just “noise.”
Commodity prices fall The recent decline in both agricultural and oil commodity prices will reduce nominal inflation pressure near-term, and may have some longer-term core inflation benefits.