Via Stephen Stanley at Amherst Pierpont Securities:
While the newswire headlines are perhaps a bit more emphatic than the actual text of Chair Yellen’s speech, the thrust of her guidance is supportive of a March rate hike. She repeats the framework that she laid out in mid-February to Congress and that a number of other Fed officials have used: “we currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect. Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” The first sentence repeats that the FOMC still expects 3 hikes (per the December dots) or thereabouts this year. The second paragraph is the final go-ahead that the markets were expecting today. She doesn’t quite lock the Committee in, but she notes that the FOMC will probably raise rates on March 15 if the economy evolves as expected. That whole data-dependent/evolving theme makes a lot of sense when the next prospective hike is six or eight weeks away, whereas in the current instance the Fed will be making its March decision in 12 days. Indeed, there is basically one important data release between now and then: the February employment report next Friday. So, if Yellen had wanted to be more explicit (and when has a Fed Chair ever tried to be terribly explicit?!?), she could have just said that ‘we’re going to go in March unless the employment report is a disaster.’ Don’t laugh. Most of the FOMC was agitating for a rate hike in June 2016 throughout April and May, and Yellen had seemingly tentatively signed off on such a move just before Memorial Day, but a stinker payroll figure for May caused the Fed to chicken out at the last minute (and after Brexit, the Fed ended up holding its fire for 6 more months). In theory, lightning could strike twice, but, as Yellen explained, the environment is very different (much healthier) today than it was in the spring of 2016. Most importantly, inflation, both total and core, have moved noticeably higher. And, for what it’s worth, I think we are going to get next Friday a strong payroll figure, a downtick in the unemployment rate, and an acceleration in the year-over-year average hourly earnings advance, i.e. a triple shot of hike-worthy data points.
Of less immediate interest, the bulk of Yellen’s speech lays out a narrative of the 2014-2016 period. In a nutshell, Yellen provides the reasons/excuses for why the Fed has been so slow to take back accommodation over the past three years. I could engage in a point-for-point rebuttal of her justifications, but what’s done is done, and what we care about now is not the past but the future. What is most interesting to me about the speech is that after justifying her own (and the Fed’s) repeated decisions to remain cautious over that period, to get to the point of justifying a rate hike in March, she has to underscore that the tone is now different than it was for most of that 3-year period. She acknowledges that risks from abroad have faded, that the labor market continues to make progress and is near full employment, and that inflation is moving higher toward the Fed’s 2% target. It is this latter fact that I had pinpointed months ago in making the argument that the FOMC would raise rates in March and would end up hiking 4 times in 2017, both very unpopular calls on the Street until a few days ago. Her about-face is important not only because it will now apparently result in a rate hike a “mere” three months after the last one, but also because of the shift in the burden of proof. Until recently, the Fed’s M.O. was that the case for each subsequent rate hike would have to be built from scratch, i.e. there would be no presumption of a series of moves. Given the litany of shocks, risks, and downside surprises that Yellen rattled off, that strategy resulted in the one-hike-per-year pattern seen in 2015 and 2016. Fast forward to 2017, and there has been a subtle shift. The mantra from the Committee, as expressed in the minutes and in Yellen’s Congressional testimony, as well as from most officials individually, is that as long as the economy evolves as expected, the Fed will be hiking gradually, i.e. consistent with the 3-4 rate moves per year embedded in the latest dot plot. This is why the Fed is preparing to follow up its December move with another rate hike so soon. We are far from on automatic pilot, but, finally, with the economy at full employment and just a shade below the Fed’s inflation target, policymakers have woken up and realized that super-easy monetary policy is no longer appropriate and that the Fed needs to remove accommodation a heck of a lot faster than 25 BPs per year.