Goldman Slashes September Rate-Hike Odds As Hilsenrath Warns Of Divided Fed

Goldman Sachs' estimate of September rate-hike odds continue to collapse faster than Hillary Clinton as the absence of a clear signal from a series of speeches by Fed officials (concluding with Lael Brainard's headfake). Goldman have reduced their subjective odds for a hike next week to 25% from 40% previously (still above market expectations of 13%) but remains hopeful for December. However, as Fed-whisperer WSJ's Jon Hilsenrath warns, Yellen faces record levels of dissent as she "confronts a divided group of policy-makers."

As Goldman's Jan Hatzius explains, over the last several days many Fed officials have expressed their views on the outlook for policy, concluding with Governor Brainard yesterday. Policymakers expressed a wide range of views, but a common element was the lack of a clear signal that the FOMC is prepared to raise rates as soon as next week’s meeting. If action were likely, we would normally see an effort to raise market expectations, such that a rate increase did not startle markets. Thus, the lack of a signal is meaningful, and lowers the probability of an increase. We are further reducing our subjective odds for a hike next week to 25% from 40% previously, and nudging up the odds that the next increase comes at the December meeting to 40% from 30%. Together these changes lower our cumulative odds of at least one increase this year to 65% from 70%.

Although it would be very unusual for the committee to raise rates in the face of low market-implied odds, we are reluctant to cut our subjective probabilities further given uncertainty about the committee’s basic framework. Based on the June dot plot and what they have said in recent months, we estimate that there are eight Fed officials who would prefer to raise rates this month (including four voters), and four who would prefer to wait (including two voters). The views of the remaining five officials (four voters) are unclear, but we had thought Chair Yellen was leaning toward a September increase, based on her comments at the Jackson Hole Symposium, as well as the two-hike baseline in the June Summary of Economic Projections (SEP). The lack of a coordinated signal from Fed leadership in recent days suggests this is no longer the case—or was never the case to begin with—and that Chair Yellen herself favors standing pat.

Both sides of the FOMC’s internal debate have outlined the rationale for either hiking or not hiking in recent weeks. Presidents Rosengren and Williams have spelled out the case for further tightening. Their view, excerpted in Exhibit 1, is that allowing the economy to overheat—by which they mean allowing the unemployment rate to fall too far below its structural rate consistent with stable inflation—could lead to excessive inflation or other imbalances in the future. It is better for the Fed to tighten gradually in advance, they argue, than to be forced to slow the economy down to a sustainable pace later.

Their position echoes the argument made by the Fed leadership in late 2015. In a speech last November, President Dudley argued that “overheating is a risk” because it could force the FOMC “to tighten monetary policy more aggressively.” In that case, he argued, “the risk of a recession would probably climb significantly” due to the difficulty that the Fed has historically faced in engineering a soft landing. Chair Yellen made much the same argument in a speech last December, noting that “Were the FOMC to delay the start of policy normalization for too long, we would likely end up having to tighten policy relatively abruptly,” which “would risk disrupting financial markets and perhaps even inadvertently push the economy into recession.”

 

Governor Brainard spelled out the case against further tightening in a speech Monday afternoon, excerpted in Exhibit 2. She argues that the Fed officials should wait for further tangible evidence of a pick-up in inflation, especially given uncertainly about both how much slack remains and the strength of the Phillips curve relationship. Moreover, she notes that tightening would likely lead to dollar appreciation that could depress inflation further. Finally, she argues, given the likelihood that the neutral rate is lower today and that the risks associated with hiking too soon exceed the risks associated with hiking too late, policy should be “tilted somewhat in favor of guarding against downside risks relative to preemptively raising rates to guard against upside risks.” Governor Tarullo made similar arguments in a TV interview on Friday.

 

The arguments on both sides of the current debate largely mirror those made in the run-up to liftoff. But while the FOMC ultimately decided at the December meeting that four hikes would be appropriate this year if the economy evolved in line with its forecast, as it largely has, it now appears likely to conclude its September meeting without hiking even once. While we are not ready to conclude that there has been a regime shift on the center of the committee – after all, the basic argument for tightening has not changed much since last year – our uncertainty about the committee’s framework has increased.

But as The Wall Street Journal's Jon Hilsenrath notes, Fed Chairwoman Janet Yellen will spend the week before the central bank’s Sept. 20-21 policy meeting conferring behind the scenes with 16 officials to listen to their views and plot out a plan for the meeting. She confronts a divided group of policy makers and the potential for more internal dissent than has been common during her tenure running the Fed since 2014.

With the jobless rate at 4.9%, some regional Fed bank presidents believe that the labor market has largely recovered from the financial crisis of 2007-2009, and that short-term interest rates just above zero are no longer warranted. This group notes that risks to the U.S. economy from overseas have dissipated in recent weeks, strengthening the case for a move now.

 

For others, the watchword is patience. This group largely expects to raise rates this year but doesn’t see a need to act now. These officials note the jobless rate hasn’t moved much this year. Slack in the labor market is thus diminishing at a slower pace than before. That has reduced the urgency to raise the cost of credit to prevent the economy from overheating.

 

Moreover, because the economy is growing so slowly, this group doesn’t believe rates need to move very high in the months and years ahead, thus the Fed can take its time.

 

I don’t feel that we are incurring the costs of patience,” Dennis Lockhart, president of the Federal Reserve Bank of Atlanta, told reporters after a speech on Monday.

 

Fed governor Lael Brainard—who has been an outspoken voice in the camp of those who want to wait—called for “prudence” in raising rates in a speech in Chicago on Monday.

 

“I would like to find a way for us to remove some amount of accommodation, but you can’t force it,” said Robert Kaplan, president of the Federal Reserve Bank of Dallas, in an interview. “You have to remind yourself it makes sense to be patient, because I don’t think the economy is overheating.”

 

The Fed might sound like it is waffling, but Mr. Kaplan said it is simply reacting to a mixed economic backdrop. “For the public hearing this, it sounds like, ‘Boy, this is on-the-one-hand, on-the-other-hand,’ ” he said. “That’s true. It is not that the Fed is being so agonizingly judicious. It is that the economy is expanding at a very moderate pace, and inflation has been very slow to get to our target, and we’re reacting to that, and that’s what people are seeing.”

But, a decision to delay would bring its own risks for Ms. Yellen. The Fed could be criticized for confusing market participants with mixed messages. Ms. Yellen herself argued in Jackson Hole, Wyo., last month that the case for a rate increase had strengthened. It was taken by some market participants as a sign that she was ready to move.

Officials also meet Nov. 1-2, but a move seems unlikely then, just a week before Election Day.
 

via http://ift.tt/2ct4ayd Tyler Durden

Leave a Reply

Your email address will not be published.