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All Eyes On Yellen, Again

23 August 2016 by Eoin Walsh

The big event that we’re looking forward to this week is the Jackson Hole economic symposium, which takes place in Wyoming from 25th to 27th August, with leading world economists, policymakers and central bankers meeting to discuss the issues facing global economies. A whole host of market influencers will speak over the two days, but what has provoked most debate on the desk here is Janet Yellen’s speech on Friday (10am EST) on “The Federal Reserve’s Monetary Policy Toolkit”.

Earlier this month, we wrote about where the most yield can be found in the fixed income universe, “Where-is-the-yield”, with the US markets easily coming out on top, both in government bonds and credit bonds. However, the US is also the market where the policymakers are currently engaged in debating raising rates and this obviously gives investors cause to pause when considering putting money to work.

Unlike the Bank of England or the ECB, the Fed is not giving us a clear enough steer on the future path of monetary policy. At the back end of last year we were told to expect 4 to 5 gradual hikes this year, now it’s probably just 1 hike and the timing of that is still highly uncertain, with markets pricing a September hike at around 25% and a December hike at around 50%. In fact, the recent FOMC minutes indicated that the Fed felt that they would “likely have ample time to react if inflation rose more quickly than they currently anticipated”. To confuse the picture further, we have had several Fed Governors commenting over the past week and all of them have been talking up the US economy, expecting a pick up in the second half of the year.

NY Fed President, William C. Dudley, remarked that they were edging closer to the time for a rate hike, that a September hike was possible, and that 10 year US Treasury yields did not reflect that. These remarks were given further credence over this weekend, when the Fed Vice-Chairperson, Stanley Fischer, said “We are close to our targets [on core inflation]. Not only that, the behaviour of employment has been remarkably resilient” and “looking ahead, I expect GDP growth to pick up in coming quarters”.

What we do know is that the Fed is concerned that if they cannot elevate rates from here, then they have significantly lower ammunition with which to deal with future downturns. Hence they are motivated to implement their forward guidance, but the data (and of course their primary mandate, which is an inflation target) is preventing them from doing so.

The big question for us on the desk, is what will Janet Yellen tell us at Friday’s symposium? Will she prepare the market for a “live” September, or will she just talk up the economy?

Our take on all these mixed signals here at TwentyFour is that Yellen’s fellow Committee members would probably not seek to extend a conflicting opinion ahead of such a keynote speech, so we think she will also be talking up the prospects for the economy in the second half of the year. However, we think given the Fed’s view on inflation and their ability to move ahead of it, she will stop short of guiding the market to a September hike. The November FOMC meeting is too close to the US election, so our view is she will steer towards a December hike, giving the FOMC further time to consider the improving data that they expect. Overall we expect a slightly hawkish message which should translate into a small back up in dollar yields.

We would still not read too much into such a call from Yellen, as between now and December a lot can happen, and Fed projections do not cater for interim surprises which could well make that hike harder to implement.

Our market view here is that investors, including ourselves, are eager to take advantage of the extra yield available in the US, both in rates and credit, but would like to do so at a cheaper level, and ideally without a “surprise “ rate hike going against them. So, if Yellen is indeed more hawkish than the recent FOMC minutes, investors might just get their opportunity, although the weight of money trying to follow this theory should prevent the back up in yields being too compelling!

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