Moments ago, the text of Richard Clarida’s speech “Data Dependence and U.S. Monetary Policy” was released and contrary to expectations for a dovish relent, the Fed Vice Chair backed “gradual rate hikes” even as the neutral rate remains uncertain.
Predicting that the U.S. economic expansion will become the longest on record next year, Clarida said that “as the economy has moved to a neighborhood consistent with the Fed’s dual-mandate objectives, risks have become more symmetric and less skewed to the downside than when the current rate cycle began three years ago.“
He then cautioned, somewhat redundantly, that “raising rates too quickly could unnecessarily shorten the economic expansion, while moving too slowly could result in rising inflation and inflation expectations down the road that could be costly to reverse, as well as potentially pose financial stability risks.”
While Clarida said the neutral rate remains unclear, he noted that the real federal funds rate is “much closer to the vicinity” of neutral than in Dec. 2015, he says, but actual level of neutral is “uncertain.”
There was a tone of caution however, when Clarida referenced high frequency economic indicators, noting that Umich inflation expectations remain at the “lower end’” of range consistent with price stability, while TIPS show expected PCE inflation somewhat less than 2%.
In what has been interpreted as a hawkish statement, Clarida referenced the key issue – where is the neutral rate, and will the Fed surpass it as Powell suggested two months ago – and said the process of learning about the neutral rate and optimal unemployment rate “supports the case for gradual policy normalization, as it will allow the Fed to accumulate more information from the data about the ultimate destination for the policy rate and the unemployment rate at a time when inflation is close to our 2 percent objective.”
But his most hawkish comment had to do with the size of the Fed’s balance sheet, with Clarida saying he “wants to operate with the smallest balance sheet possible while still achieving objectives.”
And, as the chart below shows, which shows the actual and projected shrinkage of the Fed’s balance sheet, there is a long way to go…
Offsetting this was somewhat dovish language regarding employment dynamics, observing the continued shortfalls in labor participation among prime age women & among 25-54 year old men particularly. On that front, Clarida said he sees room for prime-age labor participation to rise, and says productivity gains are both cyclical and structural.
Looking at the economy, Clarida had one particular warning, noting that “an improvement in business investment will be important if the pickup in productivity growth that we have seen in recent quarters is to be sustained.”
The bottom line is that reading between the lines of Clarida’s “hawkishly cautious” speech, the Fed remains data dependent:
“At this stage of the interest rate cycle, I believe it will be especially important to monitor a wide range of data as we continually assess and calibrate whether the path for the policy rate is consistent with meeting our dual-mandate objectives on a sustained basis.”
In response to Clarida’s “guarded” comments, futures have barely moved, but the dollar has rebounded from session lows, and the BBDXY was back to unchanged on the session…
… while 2019 Fed Funds saw a tiny uptick, from 28.5 to 29.5 bps.
via RSS https://ift.tt/2DZmiyf Tyler Durden