Fedspeak is Getting More Confusing -- Yellen's Jackson Hole Speech To Resolve? September Rate Hike?

Fedspeak is getting more confusing, with some Fed officials making both dovish and hawkish comments.  But, there is a chance the confusion will be resolved to some extent by Yellen's speech at the Fed's Jackson Hole conference this coming Friday.

Yellen's Speech
Yellen's speech is on the Fed's Monetary Policy Toolkit.   It would seem from its title to focus on how the Fed can respond to negative shocks when the funds rate is close to zero.  By citing other policy tools besides the funds rate, she would counter the hawks' argument for the need to have more room to cut the funds rate in the event of a negative shock to the economy.

It does not appear as if the speech should contain any specific hint regarding the September 20-21 FOMC Meeting.  Its absence would be appropriate, particularly since key August US economic data will not be available until the following week.   But, as there is no guarantee that this "no comment" will be the case, the markets are likely to trade cautiously ahead of the speech.   Stocks could maintain their modest positive bias, nonetheless, as the consensus believes stocks respond well to Yellen's speeches/testimonies.

      a.  Fear of a hike still may weigh on the markets up until the September 20-21 FOMC meeting -- unless upcoming US economic data turn decidedly soft.   I continue to think the odds are low for a rate hike at this meeting.

Fedspeak Confusion
Until recently, Fedspeak confusion stemmed from contradictory messages sent by the hawks and doves of Fed officials.  Now, this confusion has been complicated by Fed officials speaking from both sides.  Last week saw San Francisco President John Williams, a hawk, argue one day for near-zero Fed funds rates in the long run and then another day for a potential September hike.  The week also saw NY Fed President Bill Dudley, a centrist, spend most of a speech providing reasons why the Fed should not hike rates only to conclude that further monetary policy tightening this year cannot be ruled out.  Some Fed officials are clearly anxious to tighten.

Why Fed Hawks Want to Tighten
The Fed hawks tend to cite two main reasons for hiking the funds rate -- /1/ the need for room to cut the rate in the event the economy suffers a negative shock, and /2/ above-trend growth when the economy is at full employment.

Sufficiently High Funds Rate: Without enough room above the zero level, the Fed may not be able to cut the rate sufficiently to offset the impact of a negative shock to the economy.   There are some counter arguments, however:

1.  A hike in the funds rate could be the negative shock, itself.

2.  There are some negative shocks for which a rate cut is not appropriate.  This was the case in 2008, when a loss of confidence in banks' balance sheets led to a freeze-up of financial markets.  The main effect of Bernanke's aggressive cutting of the funds rate then was to boost oil prices to $140/bbl, which pushed the consumer over the cliff.  A Fed/Treasury guarantee of banks' liabilities, similar to what ECB President Draghi did in Europe, would have been a more successful policy action.

3.   The Fed has other tools with which to conduct monetary policy, which Yellen could address in her speech.

Above-Trend Growth When Economy at Full Employment:  A continuation of above-trend growth in this situation will eventually lift inflation.  But, there is a counter argument here, too:

1.  Fed hawks in the past, like Larry Meyer in the late 1990s, made the same argument.  The problem with this argument in the late 1990s, and likely now, is that other factors offset the tightness of the labor market and held down inflation.  As a result, inflation then stayed low while the unemployment rate fell to around 4.0%.   Inflation is currently stable and below the Fed's 2% target, suggesting more is going on with inflation than just a tighter labor market -- which should permit the unemployment rate to fall further without being inflationary.

A Rate Hike at the September FOMC Meeting?
The hawks, and Dudley, have emphasized that a rate hike is on the table at the September FOMC Meeting.  The recent strengthening in some US economic data -- which highlighted the risk of above-trend growth -- is likely a major factor behind their view.   This strengthening may not persist, however, as I mentioned in my prior blog.  Here is more evidence suggesting caution in reading too much into the recently strong economic data:

1.  The latest Unemployment Claims data hint that a near-term slowing may indeed be in the cards.  Besides Initial Claims staying above 260k in the latest week, Continuing Claims have climbed in the latest 4 weeks and reached their highest level since May.  These data suggest the pace of layoffs remains steady, while the re-hiring rate has weakened.  Although there is not a reliable relationship between Initial/Continuing Claims and the m/m change in Payrolls, the Claims data raise the possibility that August Payrolls will slow to below 200k m/m.

2.  The July Fed Senior Loan Officer Survey provides a reason for a near-term slowdown.   Banks, on balance, tightened lending standards on C&I and Commercial Real Estate Loans.  This could help explain why hiring may be slowing.

           a. Note that commentators do not seem to have focused much, if at all, on these survey results.

           b.  The last time I looked at Lending Standards on C&I Loans, I found a clear inverse relationship with the funds rate -- the tighter the lending standards, the lower the funds rate.   The relationship suggests that a near-zero funds rate is appropriate currently.