Yellen stuck to the topic of financial stability. She made no news there: Regulatory reforms have made the banking system much more resilient, but there is room for reform, especially lowering the burden on smaller banks. As expected, her defense of the post-financial crisis regulatory framework drew a contrast with the President’s agenda for lightening regulation. It was consistent with our preview (link).
The only word with respect to the macroeconomy was “substantial.” She said: “Substantial progress has been made toward the Federal Reserve’s economic objectives of maximum employment and price stability.” We don’t see any implication of this word choice.1 The implication for the FOMC is: Stick to the plan to announce a balance sheet reduction in September and to gradually raise the fund’s rate toward its neutral level.
And with respect to a December hike in particular: This speech had no implications. The status remains: to be determined. We discussed our view of the December rate-hike decision in a recent piece (What Will It Take to Raise Rates in December?). If Yellen and her colleagues judge that the underlying rate is somewhere around 1¾%, near 2%—recall that the 12-month core PCE inflation rate was 1.9% for most of the period from August 2016 to February 2017—and with sufficient confidence, absolutely go in December, indeed with more urgency. It’s quite possible they will make this judgment even if the 12-month core PCE inflation rate is still only 1.5% at the time of the December meeting: Indeed, if future monthly readings are 1.75% annualized, that might be enough to hike, even though the 12-month rate would be only 1.46%. A December hike is still our call, but the probability has been declining with continued soft inflation readings and now is close to 50%.
She didn’t even touch on any of the areas we thought she might that would approach on relevance for monetary policy. Not surprising. Stick to the topic. Nothing needed to be said about monetary policy’s role with respect to financial stability concerns. We know the party line. We thought she might talk about asset valuations, but that could have taken her focus away from the discussion of the evolution of the banking sector, where systemic risk is concentrated, and away from the regulatory reforms that improved the resilience of the banking sector.
She didn’t comment whatsoever on the relative roles of macroprudential policy and monetary policy in addressing financial stability concerns or even comment on current asset valuations and risks to financial stability.
Her in-depth discussion of regulatory issues stuck to the party line: While the main thrust of her speech was to defend the regulatory framework put in place in response to the financial crisis, she argued that “a
1 At Yellen’s December 2016 FOMC press conference, she noted that “my colleagues and I are recognizing the considerable progress the economy has made toward our dual objectives of maximum employment and price stability.” In our view, “considerable” and “substantial” are equivalent in meaning and tone.
a broader set of changes…may deserve consideration.” The change that she cited represented an easing of regulatory burden rather than an addition: “adjustments that may simplify regulations” for small and medium-sized banks. She also suggested that any additions to the regulatory framework “should be modest.”
Bottom Line: Yellen’s speech does not change the prospects for a September balance sheet announcement and a December hike, nor does it offer any additional insight into who will be Fed Chair.