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05 27 2016 | by Victor Xing | Central Banks

Yellen and a cautious path to higher rates

Yellen and a cautious rate path

During today’s Q&A session at Harvard’s Radcliffe Institute for Advanced Study, Fed Chair Yellen echoed comments by New York Fed President Dudley (2 hikes in 2016 “reasonable”) and Governor Powell (rate hike appropriate “fairly soon”) that higher rates would probably be appropriate in the coming months:

It is appropriate, and I have said this in the past, I think for the Fed to gradually and cautiously increase our overnight interest rate overtime, and probably in the coming months such move would be appropriate

Following this week’s strong 2 year auction and decent 5 year supply, futures implied rate hike probabilities for the remainder of the year had declined to slightly above 1 hike, and Yellen’s latest acknowledgement subsequently erased recent gains in front-end rates, boosted the dollar, and re-flattened the yield curve:

30 day federal funds futures erased recent gains following Chair Yellen’s Q&A comments
Dollar rebounded from mid-week weakness following Yellen’s comments (the recent spike on May 18 was from the FOMC minutes
FV futures (blue, RHS) pared gains vs. WN futures (green, LHS) to re-flatten the curve

Members of the Board vs. Fed Presidents including Dudley

Despite market’s sharp repricing of rate hike probabilities, there exists a notable difference between Chair Yellen cautious stance and optimism expressed by New York Fed President Dudley, Atlanta Fed President Lockhart, Boston Fed President Rosengren, among other regional Fed officials.

During today’s Q&A, Yellen again highlighted the asymmetries in the effectiveness of monetary policy in the vicinity of the zero lower bound, which has been a cornerstone behind Federal Reserve’s argument for caution:

This is a concern.  One of the reasons I believe it is important for us to be cautious in raising interest rates, is precisely because if we were to raise interest rates too steeply, we would to trigger a downturn or contribute to a downturn, we have limited scope for responding, and it is an important reason for caution.

This comment is in-line with the cautious tone during Governor Powell’s Q&A at the Peterson Institute for International Economics.  During the event, Governor Powell cast doubt on the “dot plot” (which is the basis behind President Dudley’s 2 hikes comment), saying “anyone’s ability to forecast beyond the next few months is really not so great.”

On the topic of asymmetric risk, Governor Powell approached the topic from the direction of caution, that risks of waiting (later hike) is “not so great.”  Relative to President Dudley’s hawkish comment that current policy path is “not sustainable,” Governor appeared less concerned about the financial stability risk.

Taking it as a whole, a picture emerges with Yellen as the “dovish centrist,” with Brainard (who is scheduled to speak on Friday, June 3rd) and Powell appeared as more dovish, and Dudley slightly more hawkish, followed by other Fed Presidents with the exception of Evans and Kaplan.

This puts July as a likely compromise on the next rate hike, subject to changes in financial conditions, which has tightened following Yellen’s latest comments.

Next article05 19 2016 | by Victor Xing | Capital Markets

President Dudley and financial conditions