The market is eagerly awaiting the President’s decision on Fed Chair. We wrote about the White House’s criteria and our assessment. (See Checking the Boxes: The White House’s Criteria for Fed Chair.)
Policymakers’ Comments
Low inflation was cited as a reason to let labor market improvement continue. Williams said: “A couple more years of roughly 4 percent unemployment and we’re going to learn a lot more about this labor force participation issue and really test this out to see if there’s more people who can come back into this labor market.” On inflation, he didn’t “see any signs that somehow the inflation process is fundamentally changed.” Yellen’s view was similar: Despite “surprisingly soft” recent data, “my best guess is that these soft readings will not persist, and with the ongoing strengthening of labor markets, I expect inflation to move higher next year.” She said that “wage gains appear moderate, and the pace seems broadly consistent with a tightening labor market once we account for the disappointing productivity growth in recent years” Later, she added that, although she saw temporary factors as having held down inflation, she “would not claim that’s all of it.” Dudley was hopeful that “pressure on resources will drive up wages over time.” Kaplan thought growth “will be sufficient to take more slack out of the labor market.” His forecast for 2017 GDP growth was just below 2.5%. Harker noted that the labor force participation rate “will likely drop a couple more tenths of a percentage point over the next few years.” He seemed sympathetic to the idea of running a so-called hot labor market to reduce slack: “Since growth is fundamentally growth in productivity plus growth in the labor force, there’s a real incentive for us to get every last person off the sidelines that we possibly can.”
Yellen cited a rising r-star as warranting further gradual rate hikes: “We expect the neutral level of the federal funds rate to rise somewhat over time, and, as a result, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion.” Nonetheless, in separate remarks, she noted that “the probability that short-term interest rates may need to be reduced to their effective lower bound at some point is uncomfortably high, even in the absence of a major financial and economic crisis.” Thus, “a significantly less severe economic downturn than the Great Recession might be sufficient to drive short-term interest rates back to their effective lower bound.” Williams saw the median projected path from the September FOMC meeting as appropriate: “My own view is we want to continue this gradual pace of increase. One more rate increase in December and three more next year is a pretty good starting point.” Dudley also saw a December hike as warranted: “We went into 2017 showing a median of three rate hikes, and so far we’re on path to actually, for that to actually bear out.” Kaplan said: “I will be looking for evidence that building cyclical forces have the prospect of offsetting structural headwinds…It is likely we will see greater evidence of this progress [toward 2 percent] and, as a consequence, it will be appropriate to continue the process of gradually removing monetary accommodation.” Harker was less optimistic: “We have to see how inflation dynamics roll out over the next couple of months and we have to make sure that the process of ceasing reinvestment is, as we anticipate, not very disruptive to the market…No need to firmly commit [to a December hike.]”
Policymakers were cautious in incorporating any fiscal stimulus into their forecasts. Williams argued that “we don’t need fiscal stimulus in the short run — our economy is strong, we’re in a good place.” Dudley was more optimistic: “just broadening the tax base and simplifying the tax code would be a big benefit” but noted that “we’re a long way from tax reform at this point.” Kaplan saw “Changes in fiscal policy and structural reforms could [providing] upside” to 2017 growth but “U.S. policy regarding trade and immigration bears watching and could have some negative impact on future rates of growth.” Yellen saw the prospect of fiscal stimulus as having lifted sentiment but not yet consumer spending or investment: “It is a source of uncertainty…We’ve taken…a kind of wait-and-see attitude.”
Financial stability was a concern for several policymakers. Harker cited high asset prices: “That’s why I would like to prudently move up to the neutral real rate as quickly as possible.” Kaplan said: “I don’t see undue imbalances, but I’m continuing to look for them, and I’m aware that with rates this low, it will cause people to take more risk, and it may cause these imbalances to build. And I’ve learned when they do build, they can build very quickly, so we have to be very vigilant about this.” He also wanted to avoid approaching an inverted yield curve: “whatever we say about the neutral rate, I personally do not intend to raise the fed funds rate so that it’s nudging up against the ten-year Treasury rate.” Yellen noted that “broader financial stability risks depend on more than just asset prices and it may also be important just why asset valuations are high. So one factor that clearly comes into play is an environment of low interest rates and central bankers like many market participants have been adjusting our notions of [expected longer-term rates.]”