Article / 23 August 2016 at 9:00 GMT

Is Yellen about to demote the Fed?

Head of FX Strategy / Saxo Bank
  • US interest rate hike speculation growing stale
  • Jackson Hole speeches may offer new direction
  • Fed 'may be about to administer its own demotion'

By John J Hardy

The media’s longstanding obsession with the likelihood and timing of the next Federal Reserve interest rate hike has long turned stale as it has devolved into a question of whether the Fed hikes once over the next 12-18 months or not at all. 

Because an irrelevant, 25 basis point move is the only Fed policy uncertainty for the relevant horizon of market expectations, FX market  moves have continued to lose amplitude, with only the Brexit vote and ensuing sterling weakness showing that the major exchange rates maintain a pulse.

This Friday, Fed chair Janet Yellen will speak at the Kansas City Fed’s high-profile, annual Jackson Hole symposium. It’s a rare opportunity to hear the world’s most important central banker’s thoughts on big-picture policy observations and to sidestep the short-term focus on the "when and whether" of the next hike. 

Jackson Hole, Wyoming
Both the nature of the event and the landscape itself encourage 
attendees to take the long view. Photo: iStock

Heightening the anticipation around this speech is not only the clear disagreement among Fed officials on the need for another hike, but also new hints that some members are not satisfied that the current monetary policy toolbox is appropriate for what ails the US economy in the longer run.

First, San Francisco Fed president John Williams – a key subordinate under Yellen’s presidency of the SF Fed– published an essay claiming that the natural interest rate is now much lower than it has been in the past. This, Williams claimed, increases the danger that the policy rate hovers near or below zero and that recessions will become longer and worse because monetary policy can’t hold sway as strongly as it did in the past. 

To avoid this, Williams’ essay called for fiscal and other policies (like nominal GDP targeting, or basically printing your way to nominal if not real growth). Similarly, Fed vice-chairman Stanley Fischer gave a speech just this weekend that concluded with remarks questioning whether monetary policy is the right tool to pull the US economy from its longer-term challenges like slowing productivity growth. Rather, he points to “effective fiscal and regulatory policies” as a more productive avenue.

This all paints a tantalising picture, especially as Fischer is a heavy hitter at the Fed and given Williams’ association with Yellen’s time at the San Francisco Fed. Confusing the issue yet further was a recent hawkish talk on the need for new rate hikes from influential New York Fed president William Dudley and even from the SF Fed’s Williams.

But will Yellen deliver anything this Friday? She has been a very cautious mover since assuming the helm in early 2014. And would a shift in long-term policy observations be seen by the market as dovish or hawkish? 

On the one hand, the admission that the Fed is in a new, growth-compromised world is dovish as it points to a central bank that won’t hike much because it doesn’t see inflation returning until fiscal stimulus and structural reforms arrive in force. This would also remove a portion of the market’s responsiveness to incoming data. 

On the other hand, any near-term rate hike talk is hawkish because the market thinks it unlikely that the Fed hikes more than once in the coming 12 months. Could the Fed instead hike two times quickly and then tell the incoming Congress and president next year that it is “your move”?

Washington, D.C.
Is it even possible for the Fed to move in a 'non-political' 
manner this election season? Photo: iStock

Essentially, the Yellen Fed may be about to administer its own demotion after former chairs Alan Greenspan and Ben Bernanke played masters of the universe for 25-plus years by pointing to the Fed's inability to provide what the economy needs for the longer term. 

The stakes are very large if the Fed is indeed making this longer term policy pivot, having tired of the corner it has been backed into...

The interesting rhetoric this Friday, if any, will inevitably be couched in cautious phrases or hinted at only obliquely. But if a message is delivered, no matter how indirectly, the impact could be quite large on a currency market desperate for new developments.

— Edited by Michael McKenna

John J Hardy is head of FX strategy at Saxo Bank

Juhani Huopainen Juhani Huopainen
"the impact could be quite large on a currency market desperate for new developments." - exactly. News-hungry, holiday-ridden markets and media could overreact. This would later be followed by Fed speeches that downplay the overeager interpretations.


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