3 Takeaways from Yellen’s Jackson Hole Speech

Fed Chair Janet Yellen really delivered when she gave her Jackson Hole speech on Friday. But if you missed it, here are the 3 key takeaways from her speech.

1. Upbeat on the U.S. economy

Growth

Yellen acknowledged that economic growth “has not been rapid,” alluding to the weak growth in the first half of the year. But she was quick to add that “it has been sufficient to generate further improvement in the labor market.”

Looking ahead, Yellen expects to see continued “moderate growth” in real GDP “led by solid growth in household spending.” However, she also lamented that “business investment remains soft and subdued foreign demand and the appreciation of the dollar since mid-2014 continue to restrain exports.”

Labor Market

With regard to the labor market, Yellen first pointed out that the average job gain in the last three months was 190,000. What’s the significance of that, you ask? Well, according to Yellen’s December 2015 speech:

“To simply provide jobs for those who are newly entering the labor force probably requires under 100,000 jobs per month.”

Atlanta Fed President Dennis Lockhart also said the same thing in an August 16 statement:

“I would like to see continuing job gains, with a nice measure of cushion (above) breakeven numbers, which I would put at between 80,000 and 100,000.”

Job gains above 100,000 is therefore good, although Lockhart also added that he “would find monthly gains of 150,000 to be very encouraging.”

Aside from solid job gains, Yellen also pointed out that the jobless rate “remained fairly steady this year” and that “broader measures of labor utilization have improved.”

Finally, Yellen said that she and other FOMC members expect “additional strengthening in the labor market.”

Inflation

As for inflation, Yellen said here usual line about inflation running below the FOMC’s 2% target while adding that this is due in part to “transitory effects” that will start to fade soon. As such, inflation is expected to rise to 2% “over the next few years.”

2. Higher chance of a rate hike

Given the upbeat outlook on the U.S. economy, Yellen concluded that “the case for an increase in the federal funds rate has strengthened in recent months.”

She provided a couple of caveats, though, namely that monetary policy is data-dependent and that “as ever, the economic outlook is uncertain.” Thus, “monetary policy is not on a preset course.”

Also, do note that Yellen’s statement was rather vague in that it didn’t really give a definite date on when the next rate hike will be.

3. Fed’s Monetary Policy Toolkit

The rest of Yellen’s speech was devoted to the Fed’s Monetary Policy Toolkit and largely inconsequential to the market, so you can skip this part if you like. The only real takeaway here is that Fed officials project that they will have to gradually hike rates until 3% and then keep it there in the longer run.

Anyhow, if you want a quick summary, Yellen first talked about the pre-2008 debt crisis toolkit, which only included raising or lowering the federal funds rate through open market operations (i.e. rate cuts/hikes).

The Fed’s toolkit was later expanded to include the paying of interest on banks’ reserve balances (another means to control the federal funds rate), large-scale asset purchases (i.e. quantitative easing), and “increasingly explicit forward guidance” (e.g. saying that a September rate hike is possible).

Yellen concluded her history lesson by saying that the Fed’s tools were effective, which is why the Fed was able to hike last December despite “unusual headwinds” such as “unfavorable demand shocks from abroad, a period of contractionary fiscal policy, and unusually tight credit, especially for housing.”

Looking forward, the Fed will have to gradually hike the federal funds rate, “settling at about 3 percent in the longer run,” as I noted earlier. However, this is significantly lower than the 7% average between 1965 and 2000. The Fed thereby has limited scope for rate cuts if another crisis or recession comes to smack around the U.S. economy.

To address this, “future policymakers might choose to consider some additional tools that have been employed by other central banks,” which may include exploring “the possibility of purchasing a broader range of assets.”

Yellen then stressed that she and the other current FOMC members are “not actively considering these additional tools and policy framework.” I guess she doesn’t want to give the market the impression that the Fed has an easing bias rather than a hiking bias, huh?

Anyhow, Yellen continued by saying that the Fed’s monetary policy can only do so much in a severe economic downturn, and that the U.S. government’s fiscal policy also has a large and important role to play.

Finally, she added that:

“[A]s a society we should explore ways to raise productivity growth. Stronger productivity growth would tend to raise the average level of interest rates and therefore would provide the Federal Reserve with greater scope to ease monetary policy in the event of a recession. But more importantly, stronger productivity growth would enhance Americans’ living standards.”

The Greenback’s Reaction

Yellen’s statement that “the case for an increase in the federal funds rate has strengthened” cause the Greenback to spike higher across the board as a knee-jerk reaction. However, it got pulled back down after the initial spike, likely because of Yellen’s caveats or the fact that Yellen didn’t actually give a clear message on when the next rate hike will be.

USD Index: 15-Minute Forex Chart

USD Index: 15-Minute Forex Chart

However, the Greenback bulls were persistent and their persistence was ultimately rewarded when the bears got routed after Fed Vice Chairman Stanley Fischer was interviewed by the CNBC shortly after Yellen’s speech.

In that interview, Fischer was asked if people should be “on the edge of our seat” for a rate hike as soon as September and if the market can expect more than two rate hikes this year. And Fischer replied by saying that:

“I think what the Chair said today was consistent with answering yes to both of your questions, but these are not things we know until we see the data.”

The market apparently took that as a signal that a rate hike is very likely in the cards for the September meeting since the probability of a 25 bps September rate hike jumped from just 21% to 38% before settling down to 36%, according to the CME Group’s FedWatch Tool. Rate hike probabilities also improved for the November and December meeting, although still below the 50% mark for November while just under 60% for December .

CME Group's FedWatch Tool

CME Group’s FedWatch Tool

How about you? After reading up on Yellen’s statements, as well as that of Fischer’s, and having also read up on what and how the other voting FOMC members think, are you convinced that there will be a September rate hike? Share your thoughts in the poll below!

 

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