US: Yellen the reluctant hiker – RBC CM

Research Team at RBC Capital Markets, noted in the wake of the FOMC that despite some overt capitulation to the hawks (there were 3 dissents from this group after all), the committee still maintained a pretty high hurdle to raise rates this year.

Key Quotes

“To be sure, noting that the case for a rate increase has strengthened and that the risk assessment is balanced gave the market plenty ammunition to support the idea of a rate hike in December. But despite many market participants' focus on the hawkish elements of this meeting, there were some significant dovish developments that bear mentioning--and that will ultimately, in our view, carry the most weight when thinking about a hike this year. We'd highlight specifically the further depression of the FF path and Yellen's renewed focus on labor market slack.

Note that the long-run FF median was knocked down again, to 2.875% from 3.0%, and is now all the way down from 4.0% at the beginning of 2014. This is a large shift in what should theoretically be a slow-adjusting, fundamentally stable metric. What is puzzling about this move is that the reduction in the long-run FF best guess is coming at a time when the Fed’s own models suggest the natural rate (i.e., the infamous rstar) has actually been drifting higher in recent quarters. Accordingly, this estimate of the long-run FF is, we think, being used as a de facto forward guidance tool--and it just got more dovish.

Beyond this, one of the things Yellen did in what was a characteristically dovish press conference is reiterate the idea that there still exists an output gap in the labor market--i.e. slack--and that it has potentially been widening. We had floated the idea that the doves would latch on to the fact that despite averaging 180k+ per month in payroll this year the unemployment rate has moved sideways.

Yellen acknowledged the fact that the reason behind this sideway drift in the u-rate really comes down to folks re-entering the labor force, which is obviously a positive development. But she also views this as a renewed expansion of labor market slack. To wit: “with labor market slack being taken up at a somewhat slower pace than in previous years, scope for some further improvement in the labor market remaining, and inflation continuing to run below our 2 percent target, we chose to wait for further evidence of continued progress toward our objectives.” In other words, from Yellen’s lens it is now conceivable that it will take further gains in the employment backdrop before we begin to witness more pronounced wage pressures. This essentially means the horizon to hitting the 2% inflation target just moved further out.

Given this, it not surprising that the Chair felt the need to note that the economy is not about to “overheat” no less than 6 times in her presser. This was all in the context of this gem: "These are complicated, complex issues and it just isn't straightforward exactly how to interpret what is appropriate policy, and exactly what is going on in the economy." You almost feel bad for the Fed--until of course you realize that knowing the ins and outs of the economy is exactly what they are charged with. Either way, at a minimum this uncertainty drives home Yellen’s reluctance to hike rates.”