The End Of Summer Complacency Case Analysis
The end of summer has seemingly brought a fresh wave of sobriety to global financial markets. The catalyst was Fed Chair Yellen’s speech at the Federal Reserve Bank of Kansas City’s annual conference on monetary policy in Jackson Hole. She stated that the case for a higher federal funds rate had recently strengthened. This hot topic of conversation subsequently shifted to one of how many hikes are potentially likely in 2016, as well as their timing. Chair Yellen’s intention was to put into play the 20-21 September Federal Open Market Committee (FOMC) meeting as an opportunity to raise the federal funds target. Meanwhile, Fed Governor Lael Brainard, arguably the most dovish member of the Board of Governors, cautioned …show more content…
In order to eradicate these threats, the FOMC needs to drive the unemployment rate below the natural level to ensure the onset of overheating in the economy. The current unemployment rate is 4.9% and stands just above the FOMC’s estimate of the natural rate of 4.8%. The current expansion is 7 years old, and, historically, the FOMC has attached higher policy weights to lagging economic data, such as wage and price inflation, at this mature stage of the business cycle. This stance is, therefore, consistent with the traditional view that only bad outcomes occur once the unemployment rate breaches its natural level to the downside. The reason is that monetary policy is unable to fine tune the unemployment rate due to lags in the transmission mechanism. If overheating is triggered by an overly-accommodative stance, then policy settings cannot, therefore, be tweaked to guarantee its quick eradication. Hawkish members of the FOMC would consequently argue that policy conduct should be viewed over the longer-term in terms of achieving its dual mandate. By contrast, the FOMC doves, notably Governor Brainard, are somewhat more short-term focussed by arguing that the costs of overheating are smaller, largely due to a much lower natural rate of unemployment than deemed by other members, thereby implying a much higher degree of near-term economic slack. …show more content…
The next FOMC meeting will potentially reveal if Chair Yellen still embraces the view that monetary policy risks are asymmetric, where the costs of overheating are lower than prematurely raising the policy rate.
Paying interest on bank reserves is now backfiring due to the significant flattening of government yield curves, thereby increasing the incentive for banks to hoard cash at the expense of more capital-intensive credit creation.
Central banks continue to experiment with unproven and unconventional measures, including corporate bond buying by the BoE and the prospect of deeper negative interest rates invoked by the BOJ.
The Great Currency War has not fully played out, and there is a good chance that risk aversion could increase in Q4 as central banks struggle to prolong the efficacy of their unconventional