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06 06 2016 | by Victor Xing | Central Banks

Yellen on “considerable and unavoidable uncertainties”

Chair Yellen’s four areas of uncertainty

Fed Chair Yellen’s speech at the World Affairs Council of Philadelphia initially appeared less dovish as expected – she emphasized that “one should never attach too much significant to any single monthly report,” as she outlined her “largely favorable” assessment of the U.S. economy.  Nevertheless, the Fed Chair’s acknowledgement that “recent signs of a slowdown in job creation bear close watching” stood in contrast to her optimism on the aggregate progress of the economic recovery since the Great Recession.

Indeed, like many market participants, the Fed Chair is also trying to determine if the May jobs report was an “aberration” or a “harbinger of a persistent slowdown in the broader economy.”  Facing conflicting data, Chair Yellen will likely be sympathetic to Governor Brainard’s “watchful waiting” policy argument.

Chair Yellen on Friday’s jobs report:

So the overall labor market situation has been quite positive. In that context, this past Friday’s labor market report was disappointing. Payroll gains were reported to have been much smaller in April and May than earlier in the year, averaging only about 80,000 per month.2 And while the unemployment rate was reported to have fallen further in May, that decline occurred not because more people had jobs but because fewer people reported that they were actively seeking work. A broader measure of labor market slack that includes workers marginally attached to the workforce and those working part-time who would prefer full-time work was unchanged. An encouraging aspect of the report, however, was that average hourly earnings for all employees in the nonfarm private sector increased 2-1/2 percent over the past 12 months–a bit faster than in recent years and a welcome indication that wage growth may finally be picking up.3

Although this recent labor market report was, on balance, concerning, let me emphasize that one should never attach too much significance to any single monthly report. Other timely indicators from the labor market have been more positive. For example, the number of people filing new claims for unemployment insurance–which can be a good early indicator of changes in labor market conditions–remains quite low, and the public’s perceptions of the health of the labor market, as reported in various consumer surveys, remain positive. That said, the monthly labor market report is an important economic indicator, and so we will need to watch labor market developments carefully.

… and the Fed Chair sees more questions to be answered:

Unfortunately, as I noted earlier, new questions about the economic outlook have been raised by the recent labor market data. Is the markedly reduced pace of hiring in April and May a harbinger of a persistent slowdown in the broader economy? Or will monthly payroll gains move up toward the solid pace they maintained earlier this year and in 2015? Does the latest reading on the unemployment rate indicate that we are essentially back to full employment, or does relatively subdued wage growth signal that more slack remains? My colleagues and I will be wrestling with these and other related questions going forward.

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Yellen during Q&A following her speech at the World Affairs Council of Philadelphia

To anchor her cautious approach to downside data surprise, Chair Yellen outlined four areas of “considerable and unavoidable uncertainties” on her economic outlook and the Fed’s rate path.  In her view, policymakers should expect “to be surprised in the future just as we have been surprised in the past:”

  • Uncertainty involves the thrust and resilience of domestic demand
    • Future direction of consumer spending
    • Labor market performance
  • Uncertainty pertains to economic situations abroad
    • China growth / FX policy
    • Brexit
  • Uncertainties over the outlook for productivity growth
  • Uncertainties on inflation and inflation expectations
    • Oil and dollar can “move unpredictably”
    • Estimates based on the Philips Curve had been imprecise
    • Market-based inflation expectations had “moved enough” to warrant “close attention”

Taking her speech and Q&A remarks as a whole, Chair Yellen acknowledged the latest Payrolls data as an unexpected disappointment in an otherwise highly encouraging time series, and she is cognizant of its implications: either an transient anomaly or a nascent hint of economic weakness to come.  Repeating her argument of asymmetric risk with rates near the zero lower bound, the Fed Chair gave financial markets a more balanced assessment relative to her more optimistic view from May 27 (the “coming months” remark did not make a reappearance).

Market reactions – Treasury curve bear steepened

Treasuries initially snapped weaker on Yellen’s “never attach too much significant” comment before market participants fully assessed her views.  Subsequently, the dovish language helped create a floor to risk assets (easier funding conditions while investors and policymakers ponder the mystery of the latest jobs data), and the weakness from flow to re-risk was subsequently led by long-end of the curve.  Dollar’s reaction was largely muted.

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Treasury curve bear steepened out of Yellen’s speech
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Relative to the move following Friday’s jobs report, today’s dollar gyration was relatively minor (initial spike higher, followed by a quick rout, before strengthening to pre-speech levels)
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Fed funds futures continue to price-in slightly below one hike for the rest of 2016

Next article06 03 2016 | by Victor Xing | Capital Markets

May Payrolls: policy normalization, interrupted