Key Points:
- Yellen suggests that the Fed may let the economy run “hot”.
- Rate hike path remains uncertain in face of conflicting rhetoric.
- Inflationary pressures building within the US economy.
The past week has seen some interesting statements from both the Bank of England and the US Federal Reserve on inflation expectations and their respective near term targets. Statements from both the BoE’s Mark Carney and the Fed’s Janet Yellen seemed to suggest that both central banks were prepared to let the economy run “hot” in the near term.
In particular, Janet Yellen’s statement was relatively curious given the fact that rate hikes are supposedly on the table for the FOMC in the near term. Subsequently, it seems almost counter intuitive that the central bank would wish to use the expectations channel to stoke the inflationary fires. Given that central bankers typically don’t scratch and itch without a game plane in place you would be forgiven for wondering just what Yellen and the FOMC have in mind for the coming months.
The curious thing is that both the BoE and the Federal Reserve both released these statements on the same day at roughly the same time. These statements represent a veritable verbal intervention and likely suggest that any rate hike will probably be limited to a single 25bps hike for 2016. Subsequently, as inflationary pressures continue to build within the US economy the Fed Chair just signalled that they are prepared to remain accommodative and accept higher inflation levels.
In fact, despite the recent lacklustre CPI figures, inflation is becoming readily apparent within certain sectors and US markets. For example, crude oil has just broken through the long run bear trend line whilst gold prices have also moved the same direction. US rental prices are also on the increase and this has been notable in some areas like the Seattle region.
Subsequently there are some inflationary pressures growing within the US economy which makes it all the more surprising that Yellen is looking to remain accommodative in the medium term. The problem with inflation is that it can be relatively difficult to contain when it enters a runaway phase and isn’t something that the central bank can just stamp out at will. The tightening process takes time to impact expectations so in the mean time you can have relatively high levels of inflation.
However, there are some voices of dissent within the FOMC which are currently raising the alarm. The Fed’s Fischer has been relatively consistent on his view that Fed policy is currently gutting the financial infrastructure and that he increasingly sees inflation as a significant risk. Subsequently, there are likely to be some sharp battles within the FOMC on the need for rate hikes in December.
Ultimately, the message the Fed is currently communicating is schizophrenic and likely to cause continued uncertainty on the central bank’s direction in the coming months. You can’t have both a tightening monetary phase whilst at the same time preaching accommodation and higher inflationary targets.
Subsequently, we may be facing an additional monetary mess as the Fed again tries to chew off more than they can eat. Let’s hope they can all get on the same page and actually look to the economic data for direction, without taking into consideration the financial or political implications of their policies.