Ahead of Yellen's Jackson Hole Speech

In her speech next Friday at the Kansas City Fed's Jackson Hole Conference, Fed Chair Yellen is not likely to diverge from the Fed's recent mantra of moderately strong US economic growth, gradual tightening, commencement of balance sheet reduction, and dismissal of recent low inflation prints to temporary factors -- if she mentions these issues at all.  Her speech is on Financial Stability, and may very well focus solely on arguing against Congressional attempts at weakening the Dodd-Frank law.  The speech could be intended more for Congressional ears than the markets.

While the market currently does not assign a high probability to a Fed rate hike at the September FOMC Meeting, the probability would likely rise in coming weeks if real-side data remain strong and the inflation data speed up.  Early evidence, however, suggests that while real-side data should remain strong, at least some inflation data should stay soft.  The absence of a clear-cut signal from US economic data will likely keep open the possibility the Fed will skip a September rate hike -- unless Fed officials dispel this possibility in their speeches ahead of the meeting.

Concern About Weakening Dodd-Frank
The Fed's attachment of importance to not weakening Dodd-Frank is seen in a full paragraph devoted to the benefits of financial regulation in the July Minutes, shown below.  The ideas expressed there probably offer clues to the substance of Yellen's Jackson Hole speech.

"Participants agreed that the regulatory and supervisory tools developed since the financial crisis had played an important role in fostering financial stability.  Changes in regulation had likely helped in making the banking system more resilient to major shocks, in promoting more prudent balance sheet management strategies on the part of non-bank financial institutions, and in reducing the degree to which variations in lending to the private sector intensify cycles in output and in asset prices. Participants agreed that it would not be desirable for the current regulatory framework to be changed in ways that allowed a reemergence of the types of risky practices that contributed to the crisis."

Growing Concern at the Fed About Low Inflation?
The July FOMC Minutes showed that more Fed officials were concerned about low inflation than at the June Meeting.  But, the growing concern does not appear to be at a significant level that needs addressing through monetary policy.

The June Minutes said,  "With regard to the outlook for inflation, some participants emphasized downside risks, particularly in light of the recent low readings on inflation along with measures of inflation compensation and some survey measures of inflation expectations that were still low. "

The July Minutes said, "Many participants ... saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside."  While the word "many" replaced "some" in describing the number of participants with this dovish view, the Minutes weakened the implication by using the word "might" in describing the possibility that inflation stays low.  "Might" is the weakest term in Fedspeak to describe a future possibility.

Moreover, the July Minutes also suggested that Fed officials were not ready to change their overall  view on the temporary nature of the recent low inflation prints.  The Minutes said, "Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors."  And, "most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term."

NY Fed President Dudley -- often representative of the Fed leadership thought process -- still thinks a gradual path of tightening is the right policy, according to comments he made in a recent interview.

Fed Still Sees Real GDP Growing Above Trend
The strength of the economy is what's keeping the Fed on a tightening path.  Both the Atlanta and NY Fed models project above-trend Real GDP Growth in Q317, based on data released so far.  The Atlanta Fed projects 3.8% (q/q, saar), while the NY Fed model projects 2.1%.  Trend is viewed at around 1.5%.

The 12k w/w decline in the latest week's Initial Claims to 232k supports the view of above-trend economic growth continuing in Q317 -- if Claims stay near this level in coming weeks.  The latest decline puts them below the 239-244 range seen in the past 4 months. 

Upcoming US Economic DataThere is no evidence at this point to expect August Payrolls to slow sharply --  printing, say, under 150k.   Indeed, with Initial Claims steady to lower in recent weeks, it would seem that August Payrolls will not slow much from the +180k trend, if at all.  The August Employment Report, however, is likely to show a small 0.1% m/m increase in Average Hourly Earnings, based on calendar considerations.  The y/y would be steady at 2.5%.  There are mixed considerations regarding the August CPI, and it is reasonable to expect the Core to print 0.1% or 0.2% m/m.  The y/y would print between 1.5% and 1.7%, versus 1.7% in July.