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What Janet Yellen Will Say At Next Week's Jackson Hole Meeting: BofA's Preview

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Now that even the WSJ has written about the "Fed’s ‘Schizophrenic’ Debate", explaining that If you listen to Fed officials this week, the economy is either "strong enough to absorb not one but two rate hikes in the last four months of 2016", or "on a such a new path that the central bank needs to entirely scrap and “rethink” its policy outlook because economic reality is simply not in line with their expectations", and yesterday's dovish FOMC Minutes doing nothing to help the confusion unveiled by Bill Dudley's most recent surprisingly hawkish tone (reiterated moments ago when he said that his "view on a hike hasn't changed since his Tuesday interview"), all eyes turn to Yellen's speech next Friday at Jackson Hole, with the hope that she will provide at least some clarity, whether hawkish or dovish.


That will likely not happen - after all the Fed is now entirely dependent on the market, which due to the reflexive relationship between monetary policy and risk assets, the Fed is unable to predict - but here, courtesy of BofA's brand new chief economist, Michelle Meyer, is what one can expect from Janet at a meeting where historically the Fed chair has made major policy announcements, traditionally serving to push the market higher.


Yellen goes to Jackson Hole


The focus will be on the future


On August 25-27, many key economists and policymakers will be gathering in a serene mountainside resort in Jackson Hole, Wyoming, for the annual economic symposium. The topic is “Designing Resilient Monetary Policy Frameworks for the Future”, which will likely include lessons learned from the crisis and expectations for the future conduct of monetary policy. Although market participants will be on the lookout for clues about the timing of the next hike from the Fed, we think they will be difficult to find.


The latest star at the Fed


Fed Chair Yellen is scheduled to talk on Friday, the 26th (the timing of her speech has not yet been released). She is likely to spend time discussing the latest star at the Fed – R*, which is the equilibrium Fed funds rate. The short-term R*, which represents the equilibrium rate impacted by current headwinds, is believed to be about 0% in real terms. With the real Fed Funds rate running below, Yellen will likely argue that policy is still accommodative. We expect Yellen to reiterate the desire to keep policy simulative, given a “risk-management” approach. There is asymmetry to policy when so close to the zero bound – hiking too quickly could derail the economy, but going slowly will simply mean a risk of having to play catchup. In this context, Yellen might argue that conditions are increasingly being met to further normalize rates before the end of the year, consistent with the latest communication from the FOMC. However, we do not expect guidance on the exact timing of the next hike.


The new regime


The more in-depth conversation is likely to be over how policymakers should calibrate policy going forward, assuming that R* is permanently lower and central bank balance sheets are permanently larger. This goes back to the topic of the conference – designing resilient frameworks. We think this will include debates about financial stability concerns, global central bank policy coordination, benefits/costs of negative rates and the effectiveness of forward guidance. We also suspect that there will be a conversation about inflation targeting, perhaps echoing some of the comments made from San Fran Fed Williams in his recent paper, where he made a case for considering price level targeting or nominal GDP targeting (NGDP) in an effort to allow an overshoot of inflation.


A shallow path


The acceptance of a R* that is permanently low and an emphasis on prudent risk management makes the case for policymakers to tread carefully toward the exit. In other words, central bankers should want to prolong this business cycle, with hopes that R* can head higher. From the Fed’s perspective, this will involve balancing near-term data, which call for hikes (sub-5% unemployment rate), with longer-term concerns, which require patience. The result is a very shallow Fed hiking cycle. We think this will be a theme of the Jackson Hole Conference, which means we should not expect much insight into the timing of the next Fed rate hike.





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