"So What Did We Learn From Yellen?": Deutsche, Goldman Explain

For those still unsure what Yellen's rambling, disjointed press conference meant yesterday, or are still in shock over the Fed's admitted confusion by the "mystery" that is inflation, here is a quick recap courtesy of Deutsche Bank and Goldman, explaining what we (probably) learned from the Fed and Yellen yesterday.

First, here is DB's Jim Reid:

So what did we learn from the Fed and Yellen last night? Firstly we learnt that stopping reinvestment is a sideshow for now and that the market still cares more about the probability of a December hike and where the Fed thinks inflation is heading. Just briefly on the balance sheet run-off, they have committed to the plan from the June meeting of $10bn per month ($6bn USTs and $4bn Mortgages) with an incremental increase every 3 months until we get to $50bn. However on the rates and inflation outlook the committee and Yellen were on the hawkish side. As DB's Peter Hooper discusses in his note, barring negative surprises in the months just ahead, the Fed is on track to raise rates once more this year and three times in 2018. Yellen recognised that inflation has been running low recently but put a higher blame on one-off factors than was perhaps anticipated. At the same time she noted that monetary policy operates with a lag and that labour market tightness will eventually push inflation up.


The complication for markets though is that beyond 2017, the FOMC will see a huge upheaval in its membership which could easily mean current member's thoughts are meaningless in a few months time and also that Mr Trump's fiscal plans (or lack of them) have the ability to completely change the debate. So its difficult to read too much into the current FOMC's forecasts. However for now December is very much live with the probability of a December rate hike moving from a shade under 50% to 64% by the US close (using Bloomberg's calculator).

Here are three additional takeaways from DB's Peter Hooper:

  1. Inflation: Yellen emphasized in her statement and in answers to questions that, barring negative surprises in the months just ahead, the Fed is on track to raise rates once more this year and three times in 2018. She recognized that inflation has been running low recently, and that while there was some uncertainty around this performance, one-off factors that are not expected to persist, and which have not been associated with the performance of the broader economy, have been important. At the same time, Yellen noted that monetary policy operates with a lag and that labor market tightness will eventually push inflation up. The Fed wants to avoid having to tighten policy aggressively to deal with an inflation problem and thereby cause a recession. The current low level of inflation allows the Fed to move relatively slowly and cautiously. At the same time, as Yellen noted a couple times, the labor market has continued to tighten at an impressive pace, well above the pace needed to stabilize unemployment. With unemployment already below NAIRU and expected to fall further, it is seen as prudent to make further progress in a tightening direction.
  2. Balance sheet versus fed funds rate: The preferred monetary policy tool, if needed, is the fed funds target. Yellen stated clearly several times during the press conference that balance sheet rundown will not be stopped or reversed unless the economy takes enough of a significant hit to cause the FOMC to move the fed funds rate back close to zero.
  3. Regulation and who will be the next Chair: When asked what message she had meant to give the Administration and Congress in her Jackson Hole speech, Yellen said first that it was important to keep in place progress that had been made in strengthening the financial system via enhanced capital and liquidity requirements, stress testing, and resolution plans. But she also emphasized that regulators should look for ways to ease excessive regulatory burden and simplify standards where appropriate. She seemed to give proportionately more time to the second part of this message in her answer today than she did in her Jackson Hole speech. She also noted that she would welcome and work very well with the new Vice Chair for regulation, Randall Quarles, if his appointment is approved by the Senate. And she gave a fairly accommodative answer to a question about the burden that the slow progress in getting vacant governor seats filled (especially following Vice Chairman Fischer’s departure) imposes on the Board. Finally, she gave a relatively gentle answer to a question about fiscal policy (suggesting it would be desirable to make progress on measures that would support productivity growth). Summing up Yellen’s various comments in these areas, it strikes us that this is a person who would accept a second term as Fed chair if the Administration chooses to move in that direction.

Finally, here is a Q&A from Goldman's Jan Hatzius, who now gives 75% odds to a December rate hike:

Q: Will the FOMC hike the funds rate in December?


A: Yes, probably. Fully 12 out of 16 FOMC participants—the same number as in June and almost certainly including the leadership—think another hike this year looks appropriate. Given the calendar, this amounts to fairly strong forward guidance for a December hike. Consistent with this, the committee upgraded the 2017 growth outlook from 2.2% to 2.4% and lowered the 2018-2019 unemployment forecast from 4.2% to 4.1%. And Chair Yellen again downplayed the significance of the weak core inflation data this year, saying that this “primarily reflects developments that are largely unrelated to broader economic conditions” and “as long as inflation expectations remain reasonably well anchored [these developments] are not a concern because their effects fade away.” Given this relatively strong message, we have increased our subjective probability of a hike in December from 60% before the meeting to 75% now. A hike is not assured, but we would now probably need a meaningful downside surprise in the inflation data relative to the Fed’s reduced expectations and/or a big market deterioration to forestall it.


Q: Was the longer-term message similarly hawkish?


A: No, on the contrary. The longer-term dots moved down by more than we (and we think most others) expected. The median pace of hikes was unchanged at three for 2018 but fell to just over two in 2019, and the longer term funds rate came down from 3% to 2.75%. Again, these moves were consistent with the message from Chair Yellen in the press conference. She said that the neutral real federal funds rate, r*, had fallen substantially and was likely to remain low, rising only to 0.75% in the longer term. And she also said that the risks to the (actual) path of the funds rate relative to the modal forecasts in the dot plot were tilted to the downside, rationalizing the very depressed market-implied path of the funds rate, at least in part.


Q: If the message was so mixed, why did the bond market take today’s news as clearly hawkish across the yield curve?


A: Three reasons. First, the dots represent a form of forward guidance in the near term—especially this late in the year, when a 2017 hike would almost certainly occur in December—but are only an opinion in the longer term, albeit a well-informed one. Second, the committee will see a substantial amount of turnover in coming years, and new participants could come with very different views. And third, the dots remain considerably above market pricing, even after Wednesday's downward revisions.


Q: Are you lowering your own longer-term funds rate projections along with the FOMC?


A: No, we have kept our working estimate of the terminal funds rate at 3¼%-3½% in nominal terms and 1¼%-1½% in real terms. We are more skeptical than the committee that the notion of a depressed neutral funds rate is a useful concept for predicting monetary policy in the medium and longer term. It may well be that r* will remain below the historical norm, and our projections do, in fact, build that in to some degree. There is a solid economic rationale for the idea that lower potential GDP growth should imply a lower equilibrium interest rate. But while the idea is intuitive, the empirical support for it is weak—much weaker than assumed in the well-known Laubach-Williams model of equilibrium interest rates as well as large swaths of the current macroeconomic debate. So we would put less weight on that link in projecting interest rates several years into the future, and more weight on the historical average real rate of about 2%.


Q: Any surprises on balance sheet normalization?


A: Not as far as the near term is concerned, but Chair Yellen indicated that the hurdle for stopping balance sheet rolloff is very high indeed. Our read of her discussion in the Q&A was that full reinvestment would only resume once the committee had cut the funds rate back to the effective lower bound. This would be consistent with a sentence from the March 2017 FOMC minutes that read: “A number of participants indicated that the Committee should resume asset purchases only if substantially adverse economic circumstances warranted greater monetary policy accommodation than could be provided by lowering the federal funds rate to the effective lower bound.” In the March 2017 minutes, this view was still contrasted with an alternative view held by “some” that reinvestment should resume before the committee returned to rate cuts. But Yellen’s comment today suggests that at least the current FOMC thinks balance sheet normalization is now truly on “autopilot”, barring a very bad economic outcome.


Ink Pusher Thu, 09/21/2017 - 08:10 Permalink

Even a rate hike in December won't change anything for the better on our end of the stick which still smells like shit to me even after rinsing it off in Yellen's crocodile tears.

bobsmith5 gatorengineer Thu, 09/21/2017 - 08:56 Permalink

The Rothschild's own the deep state, the government and the shadow government. They invented the deep state. They also own Soros, and Gates is just a low level minion whom they make seem a pauper by comparison. We don't know exactly what Trump is because they own the corporation called the U.S. government through a massive 20 trillion in debt.

Trump is just the president not even a board member. If he fails to take down the deep state and the banksters, who own this corporation he is now the president, then absolutely nothing will change.

Yes, this IS something very, very ugly and extremely evil.

In reply to by gatorengineer

spastic_colon Thu, 09/21/2017 - 08:20 Permalink

no...we learned that the actual reductions dont start until next month and appear they will last 50 years....so net zero reduction.....the papered over recession/depression can continue behind the scenes.

E. Phil Chew Thu, 09/21/2017 - 08:20 Permalink

We learned - and have known all along - that Ms. Yellen is a political agenda-driven hack and that's the only thing that matters to her and her owners.Fasten your seat belts.  Gonna be a bumpy ride.

Grandad Grumps Thu, 09/21/2017 - 08:22 Permalink

Humans blindly use data to tell them what to do in certain situations because their minds cannot visualize large numbers and long stretches of time. So, if a formula has been created that accurately predicts something (such as Dow 1,000,000), they will blindly follow the formula rather than attempt to change the parameters so that the formula becomes irrelevant.

The Fed appears to be a slave to its dot plot rather than changing parameters (such as getting rid of the Fed) to get a better outcome.

Hubbs Thu, 09/21/2017 - 08:48 Permalink

I don't understand the apparent ZH double standard. On one hand, ZH posts articles about  how Goldman Sachs, JP Morgan, Wells Fargo et al are corrupt and manipulate the hapless public, yet their "analysts,"  whom one would therefore conclude are "plants" by these financial crooks, have their opinions regularly cited. What gives?

Harry Lightning Thu, 09/21/2017 - 09:14 Permalink

Fed-watching, what a bloody waste of time ! Why anyone would focus any attention at all over a more or less meaningless overnight lending rate is just so ridiculous. Stop wasting your time, there are very simple rules regarding what the Fed means to markets and the economy and if you just mfloow those rules you can stop wasting time over the thoughts and actions of meaningless over-paid, over-intellectual, wine soaked relics.Heres the rules :1) The Fed would rather ease than talk and rather talk then tighten. 2) The US economy will not change in any significant way until the Fed moves at least 100 basis point, So instyead offocusing on whhat they will do with the next 25 points in their pockets and when they will do it, focus instead on when they will reach the 200 oint plateau,  because thats when the turning points occur. 3) Sell the bond market for the first 200 points of Fed tightening, then buy it with both hands. Buy the bond market first 200 points of Fed easing, then sell with both hands. When I say the "bond market", I mean 5 Year maturities or longer. Anything less is not worth worrying about, as long as you buy short maturities at a discount you;re going to get our money back rather soon. Make a mistake on a 30 year bond and it could take a while. 4) Never make an economic decision or a trading decision based on Fed predictions, because the economics staff at the Fed never is correct. The reason why they always focus on different indicators s because all the ones they have tried in the past failed. I am almost tempted to base my economic and trading decision on the opposite to what the Fed econ staff says will happen. Follow those four rules and you should do very well and not have to listen to some white haired grandmother or some academic egghead who could not trade his way out of a wet paper bag telling you how you should do your job.The Fed should have one role and one role alone : manage liquidity in the banking system. That'ts it. If the economy is overheating, rates will rise on their own and the economy will react faster because the politics of Washington will not be able to affect the process. Same when the economy is slowing, there will be plenty of unused money available and loan rates will fall.No need for the Fed to be creating new money when there already is too much money in the banking system as ethe economy falters. The Fed's role should be to mop up excess liquidity when the banking system does not need the money, so as not to fuel inflation or weaken the currency. And whne he economy is growing too quickly, the Fed's role is to make sure that rates don't spike to a level that would cause a shock to the overall economy. Finally, when there is a situation of systemic risk as during the early days of a financial crisis, the Fed should be ready to borrow and lend as much lliquidity as possible to prevent panic from taking over the markets and the economy Case in point : when Lehman failed and the US government failed to save them, banks stopped lending in the interbank market That sudden and abrupt shutdown of the critical pipeline of liquidity that funds most bank lending in America needed to be re-opened like a person having a heart attac needs a stent to re-open the arteries. That's when the Fed serves its most important function.Everything else, including the Quantitative Easing and all the dot plots and manipulation of interest rates...al of that needs to stop because it does more haem than good. Congress needs to clip the feathers of the Fed and get them back into the role that they were originally intended to play. 

Jus7tme Harry Lightning Thu, 09/21/2017 - 12:41 Permalink

>>Everything else, including the Quantitative Easing and all the dot plots and manipulation of interest rates...all of that needs to stop because it does more harm than good.Well, is that not the reason why the Fed-watcing is occuring? So how is it a waste of time to watch and to try and avoid the ill effects of the Fed's actions? I agree that the Fed manipulaton is unpridictive for the REAL economy, but those are the presnt rules of the game.Your theory is that the Fed is stupid. My theory is that the Fed does whatever is the most profitable for the banks. Or in this case, the Fed has gone past what is profitab;e for banks and try to make it profitable for main street. At which point the banks want to stop them.PS: My definitionLiquidity: The ability to exchange (trade) long term debt for short term (more liquid) debt, or vice versa, without causing a change in the market value of either type of debt instrument. 

In reply to by Harry Lightning

virgilcaine Thu, 09/21/2017 - 10:34 Permalink

I learned Big Pharma makes 500 Billion a year in prescription opioids.  Now multiply that by 100 for the negative effect on an  Economy  and it'spopulace.

Rex Andrus Thu, 09/21/2017 - 11:42 Permalink

We didn't learn anything. We are just reminded it doesn't matter what the beards say, the fix is in. Business as usual. carry on, Scotty. Aye, capn!