No September Fed Rate HIke

Fed officials spoke last week and the bottom line is no rate hike in September.   Fed Governor Brainard reverted to her dovish views, arguing even against the hawks' new "medium term" expectation for higher inflation.   NY Fed President Dudley took a hawkish view in his speech, making essentially the points discussed in my last blog.   But, he tempered his remarks in a subsequent CNBC interview that the hurricanes could influence the timing of rate hikes -- but "that" (sounded like a rate decision) is "probably further out anyway."   The commencement of the Fed's balance sheet reduction is likely, however, -- and not impacted by the hurricanes according to Dudley. 

Brainard dismissed the idea that transitory factors were primarily responsible for the currently low inflation.   Citing the lower inflation in the past year, she said, "a 12-quarter average is typically long enough that temporary factors should not be the dominant concern."  She also argued that a ratcheting down in underlying longer-run inflation expectations means that a gradual decline in the unemployment rate will not lift inflation in the foreseeable future -- the argument made by hawks for expecting inflation to rise in the medium term.  She said, "Given the flatness of the Phillips curve, it could take a considerable undershooting of the natural rate of unemployment to achieve our inflation objective if we were to rely on resource utilization alone."

Brainard supports the commencement of balance sheet reduction.   She said, "A key upcoming decision for the Committee is when to commence balance sheet normalization. I consider normalization of the federal funds rate to be well under way, the criterion for commencing balance sheet normalization. The approaching change to our reinvestment policy has been clearly communicated and is well anticipated."   But, she thinks rate hikes are not now advisable.  She said, "My own view is that we should be cautious about tightening policy further until we are confident inflation is on track to achieve our target."

Dudley's speech implied that a September rate hike was still on the table.   He said, "Overall, the economy remains on a trajectory of slightly above-trend growth, which is gradually tightening the U.S. labor market.  Over time, this should support a rise in wage growth.  When combined with a firmer import price trend—partly reflecting recent depreciation of the dollar—and the fading of effects from a number of temporary, idiosyncratic factors, that causes me to expect inflation will rise and stabilize around the FOMC’s 2 percent objective over the medium term.  In response, the Fed will likely continue to remove monetary policy accommodation gradually."

But, in his interview on CNBC, Dudley pulled back.  He said Hurricanes Harvey and Irma will not affect the timing of balance sheet reduction, but could impact the timing of rate hikes.  He seemed to suggest that a rate hike decision is not imminent but likely to be later this year.  Besides the passing comment quoted above, he acknowledged mixed arguments regarding a rate hike,  He said, "In terms of increasing short-term rates, I think it's going to depend on how the economy evolves.  On one hand, the economy is growing above trend. That implies that we need to continue to remove accommodation. On the other hand, inflation is below our target, farther below our target than we anticipated, and we also have very easy financial conditions.  I think it's too soon to judge exactly the timing of when the next rate hike might occur. But I think the path is clear that of short-term rates are going to move gradually higher over time."   He expects US macroeconomic data to be distorted by the hurricanes near term, hurting them initially and then boosting them as recovery takes hold.  Although not said, this result could hold back rate hikes for a time beyond September.