- Fed Chair Janet Yellen’s Jackson Hole speech on Friday is expected to focus on “Financial Stability.” Yellen could signal concern about inflation falling short of 2% target. Low inflation and stagnant wages point to room for improvement in the jobs market.
There’s one thing Federal Reserve Chair Janet Yellen could omit from her speech kicking off this year’s Jackson Hole conference this Friday that might get the market’s attention: Her usual characterization of inflation as likely trending toward the central bank’s 2% target.
Not reiterating a belief that low inflation is mostly due to temporary causes would be enough to signal that she is in the camp of Fed officials who have suggested they are concerned about a recent softening in inflation readings despite a low unemployment rate. Those measures are worrisome since they suggest an economy that is running below its potential at the possible cost of more and better paying jobs.
The Fed’s preferred inflation measure slipped to a six-month low of 1.4% year-over-year growth in July. Minneapolis Fed President Neel Kashkari and St. Louis Fed President James Bullard have been among the most vocal policymakers to flag this concern, but Yellen, in characteristic consensus-building fashion since she took over as chair in 2014, has remained on the fence.
Yellen’s remarks are entitled “Financial Stability,” and therefore could skirt direct discussion of monetary policy. But given the nature of the forum and its high-profile audience – academic economists, top central bankers, and a handful of market participants – that is unlikely.
Rather than focusing on monetary policy directly, Yellen is likely to discuss how the Fed is supposed to manage its unstated third mandate of maintaining a stable financial system even as it stimulates economic growth to a level that is strong but does not generate undue inflation – or credit bubbles.
Matthew Luzzetti, senior economist at Deutsche Bank, points to Yellen’s 2014 speech on “Monetary Policy and Financial Stability” as a point of reference.
“Then, as now, financial conditions were very loose,” he writes in a research note. “Yet despite easy financial conditions at the time, Yellen’s speech concluded that the nature and magnitude of financial stability considerations as of mid-2014 were insufficient to justify tighter monetary policy.”
The question for the market now, adds Luzzetti is whether enough has changed since then “for Yellen to reach a different conclusion and send a more hawkish signal about the future monetary policy path at Jackson Hole.”
The answer is probably not. Yellen has repeatedly downplayed concerns about bubbles even as she flags pockets of the market where officials see asset valuations as high.
Asked about the issue at a Congressional hearing in July, Yellen said:
“In looking at asset prices and valuations, we try not to opine on whether they are correct or they’re not correct. But on – as you asked what the potential spillovers or impacts on financial stability could be of asset price revaluations, my assessment of that is that, as asset prices have moved up, we have not seen a substantial increase in borrowing based on those asset price movements. We have a financial system, a banking system that’s well-capitalized and strong, and I believe it’s resilient.”
Economists at HSBC see no reason to think a lot has changed since: “We believe it is unlikely that Ms. Yellen’s views on financial stability risks have changed significantly in the past month,” they told clients in a research note.
The Fed’s July meeting minutes did show officials sharpening their tone on market concerns, saying that “since the April assessment, vulnerabilities associated with asset valuation pressures had edged up from notable to elevated, as asset prices remained high or climbed further, risk spreads narrowed, and expected and actual volatility remained muted in a range of financial markets.”
Still, the general consensus, which Yellen subscribes to, is that potential asset bubbles are best corralled through strong bank regulation and high capital requirements, not tighter monetary policy. Yellen has given little reason to believe her views have changed on this.
“We think that Yellen will reiterate the view that monetary policy is a suboptimal tool for addressing financial stability considerations, while theoretically leaving the door open for monetary policy to be appropriate at some point in the future,” Luzzetti concludes.
September and beyond
In a way, market expectations that the Fed will leave interest rates on hold at its next meeting in September, waiting until at least December to make another move, provide Yellen some breathing room. In addition, the import of her words has begun to wane as markets doubt she will be appointed for a second term as chair when hers expires in February. Indeed, this could be Yellen’s last Jackson Hole conference.
Still, a dovish signal from the chairwoman would serve as a powerful reminder that the central bank has not declared ‘mission accomplished’ on a labor market that remains anemic by many accounts, including widespread underemployment and a stark absence of sustained wage growth.
The Fed has raised interest rates four times since it first began tightening monetary policy in December 2015, leaving its official target range for the federal funds rate at 1.00% to 1.25%. Before that the central bank had kept official borrowing costs effectively at zero for eight years, and embarked on several rounds of bond purchases that spiked its balance sheet to the current size of $4.5 trillion.
Investors widely expect the Fed to make a more detailed announcement at its September meeting about when it will begin to reduce that balance sheet by stopping its policy of reinvesting the proceeds of maturing bonds back into its portfolio. Still, markets have plenty of questions about the timing and pace of the planned shrinking of the Fed’s reserve base, and Yellen could help address those by tying them to financial stability considerations.