Economic Commentaries


Speakers at the Federal Reserve's annual Jackson Hole Wyo. conference seemed to talk past each other. One group expressed concern that the U.S. and global economy is in the late stage of economic expansion and inflation and growth are still intolerably low and slow. Indeed, soundings from the BOJ and ECB were in the direction of more accommodation. Others focused on unconventional policies in the U.S. in the event of a downturn, including negative interest rates; a boost to the 2% inflation target; a permanent increase in the balance sheet; targeting nominal GDP.

Of these we think negative interest rates and a boost to the inflation target are the least attractive. Targeting nominal GDP is worth consideration. But ideally this should require joint monetary and fiscal action. Unfortunately this is very likely beyond the ability of policymakers to implement in a vacuum, but fiscal expansion with central bank debt monetization is within the scope of policy coordination.

Meanwhile, in her keynote address Fed Chair Yellen rejected these extraordinary actions, suggesting that the Fed still has sufficient conventional tools to combat recession. Indeed she suggested that even these may not be needed anytime soon because the domestic business outlook is improving. In this vein the Fed Chair suggested that steps toward interest rate monetization could be taken in coming months.

The near term outlook is improved, but with growth having been less than 1% annually in the first half, anything short of recession could be called an improvement. In short, improvement is relative. In July-August the ISM manufacturing index showed deterioration. Services measures show moderation. And while spending was robust in July, vehicle sales and other indicators suggest a slowing in August. To be sure, job growth is continuing apace. But a drop in the workweek in August from a downward adjustment in July is a precursor of weaker income and production growth. Current expectations for accelerating growth should be tempered.

Is all this consistent with a move toward rate normalization in the near future? It is up for grabs because the Fed may feel compelled to regain lost credibility. But based purely on business conditions our view is that a move is unwarranted given low inflation and slow growth. A hike in the benchmark rate would boost the dollar exchange rate, further weakening commodity prices and resurrecting the thought of deflation. It would likely further flatten the interest rate yield curve and perhaps invite unnecessary volatility in the capital markets.

With these occurring in the midst of a host of political events worldwide and in this country in the next few months we would continue to expect a rate move to be deferred until December and perhaps not even then.

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