Yellen’s hawkish message adds weight to rate rumblings
Sleepy markets were jolted awake Friday when U.S. Federal Reserve chair Janet Yellen delivered a hawkish message against the mountainous backdrop of Jackson Hole, Wyo. Her observation that the case for rate hikes “has strengthened in recent months” is hardly a game changer. The statement is more of an endorsement of the tightening hints delivered by a barrage of other Fed speakers over the past two weeks rather than a new revelation. But it nevertheless adds the considerable weight of her office to rumblings about U.S. monetary policy action this fall.
A subsequent television appearance by vice-chairman Stanley Fischer injected greater clarity into her musings, as he confirmed that her comments were consistent with a possible rate increase at the next Fed decision in September.
Last week, having suspected that a hawkish message lay in store, we upgraded our odds of a September rate hike to 30 per cent, and of a rate hike by December to 60 per cent. The broader market remains a little shy of those odds, but is also warming to the idea.
The Fed’s conduct merits close watching. U.S. monetary policy is a key determinant of global interest rates, which in turn are a central cog in the world’s economic machinery. Making the matter even more relevant than usual, this extended era of ultra-low interest rates has pushed investors ever further into alternatives such as gold, credit and “bond-like” equities such as utilities. This has bound all asset classes even closer together than usual. Geographic interconnectedness has also risen, with emerging markets particularly beholden to the Fed’s charms.
What makes the Fed so fascinating today is that it is virtually alone among major central banks in raising rates, in contrast to the strategy elsewhere of ever-more stimulus. To be clear, no one thinks U.S. monetary policy has all that much heavy lifting to do – today’s “natural” interest rate is much lower than it was a decade ago. But the proper policy setting for the United States is almost certainly above its current 0.375-per-cent way station. Backing this assertion, both aspects of the Fed’s dual mandate – employment and inflation – have perked up considerably.
The U.S. unemployment rate now rests at just 4.9 per cent. Admittedly, this figure modestly exaggerates the extent of the labour force’s good cheer given a disproportionate number of involuntarily part-timers and the omission of others who have dropped out of the job market altogether. But a more holistic assessment reaches a similar conclusion: The U.S. labour market has tightened significantly, and no longer evinces much economic slack.
The U.S. inflation rate is not especially high – just 0.8 per cent – but this is something of an illusion, distorted by a commodity shock. The real story is a robust 2.2-per-cent core inflation rate and mounting evidence of accelerating wages.
It is no surprise, then, that the Fed would like to raise rates. In fact, we can surmise from recent Fed missives that two Fed participants believed conditions were ripe back in July. The relative health of the economy and financial markets since then argues that even more will hold that view by September.
To be clear, the September meeting is still partly undermined by the vagaries of Brexit aftereffects and proximity to the upcoming U.S. election. Thus, while easily conceivable, a September rate hike falls well short of likely. But to my eye, the December decision looks more likely than not. A year ago, who would have thought that the Fed would dither a full year between the first and second rate increases of this cycle?
Of course, much can happen between now and December, and such “happenings” have lately had a tendency to be nasty more often than nice. This is why we must think in terms of probabilities rather than absolutes. The next step in honing those odds will be the U.S. payrolls report due out next week.