All articles 199

12 02 2015 | by Victor Xing | Central Banks

Federal Reserve Communications Roundup (Dec 2nd)

Best moment: “inflation is like wine”

With the December FOMC meeting (Dec 15-16th) looms ahead, investors paid close attention to the latest FED communications for policy guidance – notwithstanding, it was words of wisdom from President Williams of the San Francisco Fed, whose economic research featured in Chair Yellen’s highly anticipated policy speech today, that captured our collective imagination:

“Inflation is like wine—a little bit is actually good for you.” – San Francisco Fed President Williams, in his speech Dancing Days Are Here Again: The Long Road Back to Maximum Employment.

Markets reacted accordingly:

Federal Reserve Communications - Williams
Federal Reserve Communications - Williams

Who says Federal Reserve monetary policy can’t be fun?  Read on for Chair Yellen’s speech!

FED Chair Yellen’s Speech

The Economic Outlook and Monetary Policy, December 2, 2015

Chair Yellen provided an updated outlook the following topics:

  • Policy risk management considerations
  • Inflation (part of dual mandate)
  • Broader labor market conditions (part of dual mandate)
  • Domestic and foreign risk factors
  • Neutral nominal funds rate

Overall, the FED Chair outlined her optimism in terms of FOMC Statement’s conditions to raise rates.

Reference to the FOMC Statement:

In the policy statement issued after its October meeting, the FOMC reaffirmed its judgment that it would be appropriate to increase the target range for the federal funds rate when we had seen some further improvement in the labor market and were reasonably confident that inflation would move back to the Committee’s 2 percent objective over the medium term.

Yellen’s outlook:

Ongoing gains in the labor market, coupled with my judgment that longer-term inflation expectations remain reasonably well anchored, serve to bolster my confidence in a return of inflation to 2 percent as the disinflationary effects of declines in energy and import prices wane.

In my view, Chair Yellen used one of her final speech opportunities before FOMC’s Dec 8 – 17th communication blackout to prepare the market for a rate hike at this month’s meeting, assuming economic data (both at home and abroad) do not deviate from their current trends between now and Dec 15th.

Details of her speech below

Yellen on policy risk management considerations 

Chair Yellen acknowledged asymmetry policy risk with rates at the zero lower bound, that the FED can “respond more readily to upside surprises to inflation, economic growth and employment than to downside shocks.”  However, she added the following:

Reflecting these concerns, we have maintained our current policy stance even as the labor market has improved appreciably.

It suggests risk management considerations had already been a factor on current policy stance, and that continuing with current policy may be result in excessive policy accommodation if economic conditions improve.

Chair Yellen then reiterated the risk of keeping rates at the zero lower bound “for too long,” namely that monetary policy works with a lag, and ultra low rates could also encourage excessive risk-taking (reach for yield).

Yellen on inflation
Chair Yellen acknowledged on-going softness in overall consumer price inflation, but she reiterated that it largely reflects the sharp decline in oil prices, strong dollar’s weakening effect on imported goods prices, and pass-through effects of cheaper gasoline into non-energy items.  She expects drags from these transient factors to dissipate in 2016.

Headline inflation measures vs. Core inflation (ex-food & energy) measures

Federal Reserve Communications - PCE

Yellen on labor market conditions
Chair Yellen acknowledged U-3 unemployment rate (5.0% as of October 2015) is near the FOMC’s median NAIRU projection (4.9% to 5.2%), but she stressed that policymakers cannot yet declare that the labor market has reached full employment.

Despite these substantial gains, we cannot yet, in my judgment, declare that the labor market has reached full employment. Let me describe the basis for that view.

First, Chair Yellen focused the labor force participation rate and argued that ” a significant number of individuals” who are classified as out of the labor force would find and accept jobs in an even stronger labor market.

Prime age (25 to 54) vs. headline labor force participation rate

Federal Reserve Communications - participation rate

Next, the FED Chair highlighted involuntary part-time workers, or “individuals who report that they are working part time but would prefer a full-time job and cannot find one.”  Chair Yellen acknowledged that the share of these part-time workers has fallen below 4% (3.67% to be exact as of October), but she again reiterated that “some room remains” for improvement.

U-3, U-6, as well as Part-time Workers for Economic Reasons

Federal Reserve Communications - Unemployment Rate

Yellen’s final note on labor market focused on wage growth, and she was encouraged by “a welcome pickup in the growth rate of average hourly earnings.”

Average hourly earnings vs. ECI (FED’s preferred measure of labor compensation)

Federal Reserve Communications - wages

Yellen on economic growth at home and abroad
Chair Yellen highlighted factors that have been holding down U.S. growth, and that she anticipates them to diminish in the next couple of years

  • Dollar appreciation and its impact on U.S. exports
  • Weaker foreign growth also restrained demand for U.S. exports
  • Decline in crude oil prices weighed on activities in the domestic oil sector

In regards to foreign economic risks, Chair Yellen acknowledged slowdown in the Chinese economy, but she also highlighted PBOC’s effort to stimulate the economy and that policymakers in China “could do more if necessary.”  In her view,downside risks from abroad have lessened since late summer.

Moving on to U.S. fiscal policy, Yellen outlined her more optimistic view:

A final positive development for the outlook that I will mention relates to fiscal policy. This year the effect of federal fiscal policy on real GDP growth has been roughly neutral, in contrast to earlier years in which the expiration of stimulus programs and fiscal policy actions to reduce the federal budget deficit created significant drags on growth.  Also, the budget situation for many state and local governments has improved as the economic expansion has increased the revenues of these governments, allowing them to increase their hiring and spending after a number of years of cuts in the wake of the Great Recession.Looking ahead, I anticipate that total real government purchases of goods and services should have a modest positive effect on economic growth over the next few years.

Yellen on neutral nominal funds rate

Yellen elaborated on FED’s research on the neutral nominal federal funds rate – defined as the value of the federal funds rate that would be neither expansionary nor contractionary if the economy were operating near its potential.

  • The measure is low by historical standards and is likely to rise only gradually over time
  • Decline in the neutral funds rate following the crisis may be attributed to a number of factors
    • Tighter underwriting standards and limited credit availability to borrowers
    • Household deleveraging to reduce debt burdens
    • Contractionary fiscal policy at all levels of government
    • Weak growth abroad
    • Dollar appreciation
    • Slower productivity and labor force growth
    • Elevated uncertainty about the economic outlook

Yellen further stated that as the above headwind abates, the neutral federal funds rate will gradually move higher over time (most FOMC participants projected 3.5% long run nominal funds rate at the September meeting).

Federal Reserve Communications


Speech highlights from other FED officials

Atlanta Fed President Lockhart, Assessing Economic Conditions for Liftoff – December 2, 2015

  • The December FOMC meeting may be “historic” in character, as President Lockhart expects the Committee to consider the first increase in policy interest rate in nearly 10 years
  • The FOMC’s criterion of “further improvement in labor markets” has been met, and “further improvement” is certainly attainable
  • Much of what is suppressing inflation is transitory in nature
  • There are still more data to come, but “the case for liftoff is compelling

San Francisco Fed President Williams, Dancing Days Are Here Again: The Long Road Back to Maximum Employment
President Williams prefers to begin policy normalization “sooner rather than later” for a few reasons

  • Monetary policy has long and variable lags, with research shows up to at least a year or two to reach full effect
  • An economy that runs too hot for too long can generate imbalances (financial stability risk)
  • Raising rates sooner would allow a smoother, more gradual process of normalization
  • Economy is near full strength – not quite across the finish line, but “it is definitely in sight”


Original Quora Article

Next article12 02 2015 | by Victor Xing | Capital Markets

Do banks benefit from higher interest rates?