A Hawkish Yellen Emerges: “The Rate Hike Case Has Strengthened In Recent Months”

And here we go. Here are the key highlights from Yellen's speech:

  • YELLEN SAYS RATE-HIKE CASE `HAS STRENGTHENED IN RECENT MONTHS'
  • YELLEN SAYS ECONOMY NEARING FED'S EMPLOYMENT, INFLATION GOALS
  • YELLEN: FOMC NOT ACTIVELY CONSIDERING ADDITIONAL TOOLS
  • YELLEN SAYS GROWTH NOT RAPID BUT ENOUGH TO IMPROVE LABOR MKT
  • YELLEN SAYS FISCAL POLICY COULD ENHANCE ECONOMIC STABILITY
  • YELLEN: EXPECTS MODERATE US GDP GROWTH, LBR MKT STRENGTHENING
  • YELLEN: STILL, OUTLOOK UNCERTAIN, HIKES NOT ON PRESET COURSE
  •  YELLEN: RANGE OF REASONABLY LIKELY OUTCOMES FOR FFR QUITE WIDE
  • YELLEN: ECON FREQUENTLY BUFFETED BY SHOCKS, RARELY AS PREDICTD
  • YELLEN: GROWTH 'SUFFICIENT' TO GENERATE GAINS IN LABOR MARKET
  • YELLEN: SUBDUED FGN DEMAND, USD APPREC CONT TO RESTRAIN EXPORT
  • YELLEN: US ECON 'CONTINUES TO EXPAND,' LED BY HHLD SPNDING
  • YELLEN: US BUSINESS INVESTMENT REMAINS SOFT
  • YELLEN: FOMC TOOLKIT TO RAISE RATES PROVED EFFECTIVE LAST DEC
  • YELLEN: ABILITY TO PAY IOER LIKELY TO PLAY KEY ROLE FOR YEARS
  •  YELLEN: SOME ESTIMATES PUT REAL NEUTRAL RATE CLOSE TO ZERO
  •  YELLEN: EXPECT FWD GUID, ASSET PURCHASES REMAIN CRITICAL TOOLS

Here are the key segments:

In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.

On the Fed's policy options, especially potentially selling off its $4 trillion balance sheet.

The FOMC considered removing accommodation by first reducing our asset holdings (including through asset sales) and raising the federal funds rate only after our balance sheet had contracted substantially. But we decided against this approach because our ability to predict the effects of changes in the balance sheet on the economy is less than that associated with changes in the federal funds rate. Excessive inflationary pressures could arise if assets were sold too slowly. Conversely, financial markets and the economy could potentially be destabilized if assets were sold too aggressively.

On the Fed's ongoing confusion about the future:

As ever, the economic outlook is uncertain, and so monetary policy is not on a preset course. Our ability to predict how the federal funds rate will evolve over time is quite limited because monetary policy will need to respond to whatever disturbances may buffet the economy. In addition, the level of short-term interest rates consistent with the dual mandate varies over time in response to shifts in underlying economic conditions that are often evident only in hindsight. For these reasons, the range of reasonably likely outcomes for the federal funds rate is quite wide–a point illustrated by figure 1 in your handout.

On price-level and nominal GDP targeting:

Some observers have suggested raising the FOMC’s 2 percent inflation objective or implementing policy through alternative monetary policy frameworks, such as price-level or nominal GDP targeting. I should stress, however, that the FOMC is not actively considering these additional tools and policy frameworks, although they are important subjects for research.

On the economy nearing the Fed's goals:

With the U.S. economy now nearing the Federal Reserve’s statutory goals of maximum employment and price stability, this conference provides a timely opportunity to consider how the lessons we learned are likely to influence the conduct of monetary policy in the future

On the pace of increases:

Looking ahead, the FOMC expects moderate growth in real gross domestic product (GDP), additional strengthening in the labor market, and inflation rising to 2 percent over the next few years. Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives.

On looking ahead:

Looking ahead, the FOMC expects moderate growth in real gross domestic product (GDP), additional strengthening in the labor market, and inflation rising to 2 percent over the next few years

On the poor growth in US productivity:

as 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.

As expected, Yellen did talk about the handoff to fiscal policy:

Beyond monetary policy, fiscal policy has traditionally played an important role in dealing with severe economic downturns. A wide range of possible fiscal policy tools and approaches could enhance the cyclical stability of the economy. For example, steps could be taken to increase the effectiveness of the automatic stabilizers, and some economists have proposed that greater fiscal support could be usefully provided to state and local governments during recessions. As always, it would be important to ensure that any fiscal policy changes did not compromise long-run fiscal sustainability.

Finally, hinting at the worst case, and what has sent markets surging in kneejerk reaction:

On the monetary policy side, future policymakers might choose to consider some additional tools that have been employed by other central banks, though adding them to our toolkit would require a very careful weighing of costs and benefits and, in some cases, could require legislation. For example, future policymakers may wish to explore the possibility of purchasing a broader range of assets.

And so on.

Her full speech below (link):

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Earlier:

But, there is little hope Yellen will do or say much to clear up the prevailing confusion. Here are some last minute takes by financial analysts:

“Don’t expect Yellen to give a clear guidance in Jackson Hole,” said Ulrich Leuchtmann, the Frankfurt-based head of currency strategy at Commerzbank AG. “The Fed is data dependent at this point. Yellen’s topic is the ‘Fed’s toolkit’ and in talking about this she has to speak about expansionary instruments as well. She may say she can act in all directions. There is risk of market misinterpretation."

 

"Definitely in focus today is the Jackson Hole meeting and Ms. Yellen’s speech,” said Michael Kapler, a portfolio manager at Mittelbrandenburgische Sparkasse in Potsdam, Germany. “Markets have been very, very quiet over the last few days. Most market participants are a little bit uncertain about the policy of the Fed because you’ve seen that over the last couple months they’ve been talking about interest rate hikes and then stepping back."

 

"It’s a wait-and-see holding pattern now," Chris Green, of First NZ Capital Group told BBG/ “In some ways, markets may be disappointed if they are looking for clarity for the rate decision. The usual modus operandi would be not to comment explicitly.”

 

"Markets are a bit worried about the upcoming comments from Yellen, which is understandable given how much of the market strength is due to central bank action," said Philippe Gijsels, head of research at BNP Paribas Fortis in Brussels. "The fact that some of her disciples have indicated that it may be time to raise rates again has not done much in terms of calming sentiment. She will probably try to strike a balance between an improving U.S. economy and risks abroad."

 

Chris Scicluna, head of economic research at Daiwa Capital Markets, took a similar line. "Yellen won't be able to ignore the current debate but she can't make a commitment either because there's a range of views on the FOMC," he said.

As we head into her speech, gold is rallying, oil is up, bond yields are tumbling, stocks were panic bid and vol dumped.

Live Feed (click image for link to Bloomberg Live Feed)…

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Full Speech below (no Q&A)…

 

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