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Yellen Has Some Explaining to Do

FED AND INTEREST RATE - Yellen Has Some Explaining to Do

Gold Silver Reports — Markets no longer have a framework for understanding what the US Federal Reserve plans to do with interest rates -and a policymaking meeting this week isn’t likely to shed much light. That’s a gap that Fed Chair Janet Yellen, when she next speaks to the public in late August, will have to fill. 

FED AND INTEREST RATE – Yellen Has Some Explaining to Do

It’s pretty much a given that when the policy-making Federal Open Market Committee meets on Tuesday and Wednesday, it will decide to leave its short-term interest-rate target unchanged -and the accompanying formulaic statement won’t do much to dispel growing uncertainty about how the central bank’s next steps. So the next opportunity to provide clarity will come on August 26, when Yellen is scheduled to speak at the Kansas City Fed’s economic conference in Jackson Hole, Wyoming -a venue that her predecessor used to set out the central bank’s plans for the ensuing three to six months.

Back in December 2015, when the Fed increased rates for the first time in seven years, it seemed to have a framework in place: Although it did say that the exact pace of further increases would depend on the incoming economic data, it clearly indicated that it intended to raise rates by a quarter percentage point about every three months for the next three years. Now, that guidance seems obsolete: As of Wednesday , the Fed will have raised rates exactly zero times since December.

So what’s the framework now?

My reading is that Fed officials are concerned about a number of downside risks to the economy, especially from overseas -not least of which are the weakness of Europe’s banking system and the possible repercussions of Britain’s vote to leave the European Union. They also recognise that the central bank has limited firepower to offset any shocks that arise. So they’re keeping rates low now to ensure that the economy will be as healthy as possible if the risks materialise. (I have argued that the Fed should go one step further and actually cut rates.) To be sure, the economy could also do better than expected. This would be much easier to handle than a negative scenario, because the Fed could simply raise rates to keep inflation in check -an illustration of the policy asymmetry that arises when interest rates are near zero.

My forecast is that the Fed will remain reluctant to raise rates until inflationary pressures are much stronger, at which point it will feel compelled to move at a faster pace than four times per year. This is similar to Chicago Fed President Charles Evans’ suggestion that the central bank should wait to raise rates until core inflation reaches 2%. If prices start rising at that rate, the Fed will be right to put a lot more weight on inflationary concerns than on downside risks.

That said, I don’t have any inside knowledge of what the Fed’s policy makers are thinking. They’ll have to engage in some collective soul-searching over the next couple of days, and figure out what one or two factors have been most critical in shaping their decisions so far this year. Then Yellen can use her Jackson Hole speech to explain what those factors are, and how they will guide policy over the next six months. That would be a lot more useful than providing yet another forecast path of interest rates -one that is almost sure to be wrong. — Neal Bhai Reports

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