U.S. Bond Market Week In Review: Expect At Least One More Rate Hike This Year
According to the Fed’s latest “dot plot,” the consensus is for interest rates to be 25 basis points higher by the end of the year. If everything goes according to plan, there will be at least one more rate hike by the end of the year. That means this is an opportune time to analyze recent statements from voting members of the Federal Reserve’s board to determine who’s a hawk and who’s a dove.
Hawks:
At her recent press conference, Fed Chair Yellen argued that the jobs market is strong and inflation’s recent weakness was due to transitory factors. Therefore, additional tightening is warranted:
We continue to expect that the ongoing strength of the economy will warrant gradual increases in the federal funds rate to sustain a healthy labor market and stabilize inflation around our 2 percent longer-run objective. That’s based on our view that the federal funds rate remains somewhat below its neutral level—that is, the level of the federal funds rate that is neither expansionary nor contractionary and keeps the economy operating on an even keel. Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance. But because we also expect the neutral level of the federal funds rate to rise somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion. Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.
This is an especially important position given her previous dovishness. However, she hedged her bets slightly, arguing that inflation remains soft she might adjust her position.
Dudley is also clearly in the hawkish camp:
The recent narrowing of credit spreads, record stock prices and falling bond yields could encourage the Federal Reserve to continue tightening U.S. policy, one of the most influential Fed officials said in remarks published on Monday.
"Monetary policymakers need to take the evolution of financial conditions into consideration," New York Fed President William Dudley, a permanent voter on U.S. interest rates and a close ally of Fed Chair Janet Yellen, said on a closed-to-the-press panel on Sunday.
"When financial conditions ease, as has been the case recently, this can provide additional impetus for the decision to continue to remove monetary policy accommodation," he said according to prepared remarks published by the New York Fed.
Softer Hawks
Chicago Fed President Evans is also a soft hawk:
It remains to be seen whether there will be two rate hikes this year, or three, or four—or exactly when we start paring back reinvestments of maturing assets. Regardless, the important feature is that the current environment supports very gradual rate hikes and slow preset reductions in our balance sheet.
Dallas Fed President Kaplan falls into this category as well:
I have consistently stated that I believe there is a cost to excessive accommodation in terms of limiting returns to savers, as well as creating distortions and imbalances in investing, hiring and other business decisions. Monetary policy accommodation is not costless. It has been my experience that significant imbalances are often easier to recognize in hindsight and can be very painful to address.
However, I also believe that the key secular drivers discussed earlier in this essay will continue to pose challenges for economic growth. As a result, my view is that the neutral rate, the rate at which we are neither accommodative nor restrictive, is likely to be much lower than we are historically accustomed.
Based on these considerations, I have argued that future removals of accommodation should be done in a gradual and patient manner. In that regard, I continue to believe that three rate increases for 2017, including the March increase, is an appropriate baseline case for the near-term path of the federal funds rate.
Inflation Caveat Hawks
Philly Fed President added an "inflation caveat" to his latest policy announcement: "I’m sticking to my outlook that we’re on the right path,” Harker told the European Economics and Financial Center in London, according to prepared remarks. “In the case of inflation, I’ve seen the factors exerting downward pressure as temporary.”
Yet Harker, who votes on the Fed’s monetary policy committee this year under a rotation, hedged somewhat by delaying to early 2018 the time frame in which he expects inflation to rebound to a 2-percent target. He had previously penciled in the end of 2017.
Inflation could also move Fed President Brainard away from rate hikes:
In recent quarters, the balance of risks has become more favorable, the global outlook has brightened, and financial conditions have eased on net. With the labor market continuing to strengthen, and GDP growth expected to rebound in the second quarter, it likely will be appropriate soon to adjust the federal funds rate. And if the economy evolves in line with the SEP median path, the federal funds rate will likely approach the point at which normalization can be considered well under way before too long, when it will be appropriate to adjust balance sheet policy. I support an approach that retains the federal funds rate as the primary tool for adjusting monetary policy, sets the balance sheet to shrink in a gradual and predictable way for both Treasury securities and MBS, and avoids spikes in redemptions.
I usually discount Fed President Powell because his job is related to financial regulation, not economic policy.
The Dove (singular)
The only solid dove is Minnesota President Kashkari, who recently penned an excellent article outlining his objections to the Fed’s tightening path. I’d like to add an important qualifier: he writes long, well-reasoned articles that explain his positions. In my opinion, these are must reads.
All the currently available data on the Fed governors indicates we probably have at least 1 more rate hike.
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