Economic Commentaries

Entries for August 2014

19

Were it not for nagging geopolitical tensions, Fed Chair Janet Yellen’s upcoming policy discourse at the Kansas City Fed’s annual séance would be uppermost in the market’s mind. Her speech is to be delivered at the Jackson Hole, WY. Conference this Friday.

We are not expecting new policy initiatives. Rather we think Janet will reaffirm the Fed’s intention to end its asset purchase program this fall. She is likely to highlight the improving condition of the labor market while emphasizing that more healing needs to occur. She may also take a victory lap on inflation as recent market concern about an acceleration is proving alarmist. Finally, we think the Fed Chair will emphasize that the Fed’s course of future action will be cautious and deliberate.

We doubt any of this would stop analysts from speculating on the timing of future rate hikes. However, we think this speculation is wrong headed and could precipitate a policy mistake. Specifically it is important that over the past several months the yield spread between two and ten year treasury notes has narrowed by more than one-half percentage point. This yield curve flattening has occurred as short rates have edged up while long rates have fallen amidst low inflation, economic weakness abroad, and diminishing supply. Were the Fed to begin raising short rates in this environment a further narrowing of the yield differential would likely occur as markets anticipate even more sluggish activity ahead.

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