As market watchers dissect Federal Reserve (Fed) Chairwoman Janet Yellen’s widely anticipated Jackson Hole Symposium comments, many are focusing on her statements regarding how the U.S. jobs market has not yet fully recovered.
However, while her comments certainly were more dovish in tone than most other Federal Open Market Committee (FOMC) members, she did acknowledge improving labor and inflationary conditions, and this strikes me as the most significant part of her statement. Why?
These comments from Chair Yellen, along with the recently released minutes from the FOMC’s July meeting, show a Fed that is clearly angling toward more near-term policy normalization. As such, I continue to expect that the move to higher rates will begin sooner than many anticipate, given the pace of economic growth, the Fed’s targeted objectives and the harmful economic and market effects of excessively low rates.
So, you’re probably wondering now: When will the Fed begin to raise rates? Here’s my take on the rate rise timeline to watch for now post Jackson Hole.
If the August payroll report shows continued labor market improvement, watch for a policy transition announcement at the Fed’s September meeting. Assuming that the upcoming jobs report, due out September 5, confirms the recent improving employment trend, the Fed will have room to potentially lay out its transition game plan, including the metrics to focus on regarding the pace of rate normalization, at its September FOMC meeting. The press conference for this meeting provides the Fed with much explanatory potential.
A September transition announcement could lead to rate normalization beginning as early as March. A presumed six-month period after the public dissemination of the transition plan would mean a March rate lift-off. But if the Fed doesn’t use March 2015 as the starting point, I’d expect the rate rise to begin in May or June of next year.
After lift-off, the Fed will likely normalize rates slowly until we reach a federal funds rate closer to 3%. The pace at which the Fed normalizes the rate will most likely be very deliberate, and much slower than any exit strategy (rate hiking cycle) in the past. I also expect that the destination of ultimate rate policy is to a neutral federal funds rate that will be lower than the 4% it has been at historically, i.e., closer to a 3% neutral federal funds rate.
In short, we’re at the beginning of a sooner-than-expected, and very significant, period of transition for Fed monetary policy, and given today’s slow economic growth, the path toward normalizing rates is likely to involve a slower pace and a well-defined lower rate destination than past exits.
As for what this means for markets and the economy, news of a rate rise plan could disrupt markets in the near term, but I don’t expect to see another market reaction like the 2013 “taper tantrum” following the Fed’s taper announcement.
Rather, assuming the Fed clearly lays out its transition plan and key metrics and articulates that this exit strategy won’t look like the rapid ones of the past, the long-end of the interest rate curve should move up only modestly and remain relatively stable in coming months as the yield curve flattens, and markets should be able to adjust fairly smoothly.
In addition, a well-articulated Fed plan for normalizing rates at a slower pace and with a lower destination rate than past exits is likely to imbue corporations and other economic actors with more confidence in the future. As a result, they may engage in more long-term spending and investment decisions going forward, and capital spending, housing, and investment may move forward. This, in turn, should ultimately benefit the economy and markets.
Source: BlackRock Research