After Friday’s payrolls miss, the market’s initial reaction was to aggressively fade the probability of a near-term Fed rate hike, as September odds initially tumbled, only to quickly rebound into the afternoon. What catalyzed this jump? As we reported at the time, the move was almost entirely driven by an unexpected note by Goldman’s Jan Hatzius who bucked the trend other sellside lemmings, and instead of punting the September hiking date to December, the Goldman strategist said that the weak jobs report was nonetheless “strong enough” to prompt him to boost his Sept. rate hike odds from 40% to 55%.
Realizing the severity of his prediction, and the collapse in credibility he would suffer is he is – again – wrong (as we have duly documented, the past two years have been absolutely abysmal for Goldman predictions and recommendations), earlier today Goldman took time away from his holiday schedule and penned a note to explain why he is confident that, contrary to every other forecaster, he expects a better than even chance of a rate hike to be announced in just over two weeks when the Fed meets on September 20-21.
As he puts it, Yellen’s Jackson Hole speech used “blunt language” for a Fed chair, “which would have been unnecessary if she was only trying to convey a general sense that rates would be moving higher over time, or to signal a potential hike that was still 3½ months away. There are plenty of other opportunities to prepare markets for a move before the December meeting.”
Just as important was Goldman’s take on the the consensus call that the Fed would not hike until the election. As Goldman rhetorically puts it, “wouldn’t the tactics favor waiting until December given the presidential election?” To which it responds: “This is a widespread view, but we have not found much evidence that the election calendar has an impact on monetary policy—the Greenspan Fed started to tighten in June 2004 and continued to move right through the election, and the Bernanke Fed announced the then-controversial QE3 in September 2012, not December.”
So just maybe, Yellen (and Goldman) may have it in for Hillary. The rest of Hatzius’ contrarian reasoning is laid out in the following rhetorical Q&A dubbed “Why September?“
For the sake of what little is left of his credibility, we hope he is correct this time.
From Goldman Sachs:
Today we depart from our usual US Views format and discuss the outlook for Fed policy in Q&A format.
Q: You moved up your probability of a hike at the September meeting to 55% on Friday despite a below-consensus payroll number. Why?
A: Largely because the speech by Chair Yellen at Jackson Hole suggested a relatively low bar for this report. She said that “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”. The condition was that the data must “continue to confirm” the committee’s outlook—not a very stringent test, in our view, because it signals a predisposition to think that the outlook is on track.
Q: What makes you think Chair Yellen meant a hike in September, not December?
A: Two things. First, nothing happens without a good reason in these speeches, especially as far as monetary policy signals are concerned. The phrasing “case…has strengthened” was blunt language for a Fed Chair, which would have been unnecessary if she was only trying to convey a general sense that rates would be moving higher over time, or to signal a potential hike that was still 3½ months away. There are plenty of other opportunities to prepare markets for a move before the December meeting.
Second, when Vice Chairman Fischer was asked by Steve Liesman on CNBC later that day whether the “strengthened” comment meant that we should be “on the edge of our seats for a rate hike next month” (i.e. in September), he answered “what the Chair said today was consistent with answering yes”. This wording sounded like a deliberate signal that both of them, not just Fischer personally, think September is on the table for a hike.
Q: Did this shift come out of the blue?
A: The strength of the message surprised us, but we don’t think it came out of the blue. Back in the spring, the committee was ready to go in June or July, but then the weak May payroll report and the Brexit vote interfered. Now both of these worries have dissipated, the labor market has made further headway, financial conditions are easier than they were three months ago, and no major new risks have appeared. If they thought a hike made sense then, it should make more sense now. In this context, it is also noteworthy that the number of regional Federal Reserve Bank boards asking for discount rate increases—a barometer of policy sentiment within the system—has risen further in recent months and now stands at 8 (the highest since December).
Q: Did Friday’s payroll data clear the bar?
A: It is a closer call than we’d like, but on balance we think so. First, even the 151k August number in isolation is well above the “breakeven” pace—the number that Fed officials believe is consistent with unchanged labor market slack in the medium term—of less than 100k per month. Second, the longer-term trend measures such as the 3-month average (232k), 6-month average (175k), or 2016 year-to-date average (182k) are all higher. And third, preliminary August payroll numbers have had a tendency to surprise on the downside initially but ultimately to be revised higher, by an average of 71k since 2011; Fed officials are undoubtedly aware of this.
Q: What about other indicators?
A: They have been mixed to slightly weaker. On the labor market, the August household survey was a bit soft, with a flat 4.9% unemployment rate, but jobless claims remain low and household labor market assessments have improved further. On growth, the manufacturing surveys for August weakened, but GDP tracking estimates for the third quarter have been moving higher—our own estimate is 2.9% now, the NY Fed is at 2.8%, and the Atlanta Fed at 3.5%. On inflation, the latest core PCE number was only 0.1% but the year-on-year rate still stands at 1.6%. And on wages, Friday’s average hourly earnings number was only 0.1% month-to-month, but we think it was held back by calendar effects (our forecast was 0.0% for that reason); moreover, our broader wage tracker stands at 2.6% and still signals gradual acceleration. Overall, we think these numbers are probably sufficient to “continue to confirm” the committee’s outlook, alongside the more important payroll numbers.
Q: Many market participants believe that the talk about September was only an attempt to “create optionality” in case the data were very strong and the committee felt it had no choice but to hike. Do you agree with that?
A: Not really, because it overstates the FOMC’s sensitivity to one single month of data, or maybe even one release. It is very rare for one strong payroll number to turn the committee from wanting to stay on hold to feeling they have to tighten now. (There is an asymmetry here, as one very bad payroll report in early June was largely to blame for the committee’s change of heart about a June/July hike even before the Brexit vote.)
Q: Wouldn’t the tactics favor waiting until December given the presidential election?
A: This is a widespread view, but we have not found much evidence that the election calendar has an impact on monetary policy—the Greenspan Fed started to tighten in June 2004 and continued to move right through the election, and the Bernanke Fed announced the then-controversial QE3 in September 2012, not December.
Q: How much does it matter if they go in September or in December?
A: In the grand scheme of things, not much. But September does have some tactical advantages if they think a move sometime this year is very likely. It would avoid the need to first go through yet another press conference meeting with no hike, yet another reduction in the projected funds rate path—at a minimum to a one-hike baseline for 2016—and yet another labored explanation why holding off now does not mean that the plan for higher rates has been abandoned. Many market participants believe that the FOMC likes to talk about hiking soon but ultimately always flinches. A hike in September would undermine this narrative.
Q: If they do go, how much would financial conditions tighten?
A: This is of course uncertain. As a starting point, our research has shown that a funds rate hike on average tightens financial conditions by about 20bp. The variation around this is obviously large, and there is some (weak) evidence that the effects are bigger in an environment of greater global monetary policy divergence. But we would keep two things in mind. First, our FCI is now almost 50bp easier than on May 18, the day the hawkish April FOMC minutes were published. So there is some room for FCI tightening before it looks worrisome. Second, we think the committee would combine the hike with a reduction in the projected path for the funds rate to a one-hike baseline for 2016, i.e. a message that the Fed is done for the year, as well as a downgrade in the assessment of the stance of monetary policy from “accommodative” to “moderately accommodative” or the like. We think this could help keep the FCI impact moderate.
Q: Why do you think the market is only pricing a 30% probability of a hike?
A: Part of the reason is that the recent data have been a bit softer. But the more important factor may be that markets have short memories, and fading the Fed’s willingness to tighten has been a winning trade all year. That is our best explanation for why the initial response to Chair Yellen’s Jackson Hole speech, in particular, was so small. The market only moved significantly after the Fischer interview, and even that move was largely reversed in the following days, on little new information.
Q: Would the committee move in September if market pricing stays where it is?
A: Probably not. Historically, 90% of all hikes have been at least 70% priced on the eve of the meeting. We don’t think this is a hard and fast threshold, but suspect that the committee would want the probability to be materially higher than the current 30%. So we would probably need to see some hawkish Fedspeak between now and the start of the blackout period on September 13 to keep the chance of a hike alive. A signal that the August employment report showed sufficient employment growth to confirm the committee’s baseline outlook might be enough to shift market expectations toward a hike at the September meeting.
In terms of opportunities for providing such a signal, there is not very much on the calendar at the moment—speeches by Presidents Williams (September 6) and Rosengren (September 9) as well as Congressional testimony by Presidents George and Lacker (September 7). However, unscheduled press interviews are always possible.
Q: How confident are you that we will see that?
A: Not very confident, or else our probability would be higher than 55%. That said, we are much more confident (80%) that there will be a hike before the end of the year.
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