It’s time to talk about “Fed watching.”
Fed watching, among the dullest of Wall Street activities, became elevated to an art form in the wake of the financial crisis.
Monitoring every public communication from a Fed official, parsing every Jon Hilsenrath column like a term paper, and arguing over whether “considerable time” would be dropped from an FOMC statement was Wall Street’s most-practiced and most-hated side hustle.
And now it needs to stop.
Because Fed watching, really, was about trying to figure out what the Fed would do next — launch more QE, end its QE purchases, raise interest rates, cut interest rates, and so on.
But now there is something much more interesting — and, frankly, consequential — going on inside the Marriner Eccles building as the Fed re-evaluates everything it knew about monetary policy, and the market isn’t paying attention.
Here’s Kit Juckes, a strategist at Societe Generale, on the disconnect between what Fed watching was and what it should be (emphasis mine):
“The interesting Jackson Hole debate will be about monetary policy in a world where equilibrium real interest rates are really low. Fed President John Williams raised the issue in his most recent Economic Letter. He writes that ‘countercyclical fiscal policy should be our equivalent of a first responder to recessions’ yet the press has made much more of his asking whether a higher inflation target would be a good idea, and of his observations that it is still possible for a rate hike to come in September.
That shows how difficult it is to separate the conceptual debate about policy-making, from the narrow consideration of when the Fed make its next move. Despite the fact that whenever they do act, the pace of hikes is bound to be glacial. The FOMC is obsessed with making sure that rate hikes don’t cause collateral damage by coming as a surprise and the memory of the ‘taper tantrum’ three years ago is still raw enough. Absent a surprisingly sharp pick-up in inflation, when the Fed does finally hike, the FOMC will then go back into its shell to see what happens.”
Without getting too in-the-weeds, Fed officials right now are publicly re-considering whether the US economy’s r*, the so-called “natural real rate” required for the economy to maintain the Fed’s employment and inflation goals, is significantly lower than previously thought.
If this is the case, the Fed needs to raise interest rates a lot less than it had expected over the long term. (See: plot, dot.)
San Francisco Fed president John Williams’ post on the topic published last week turbocharged this debate, as Juckes notes. Larry Summers called this “the most thoughtful piece on monetary policy that has come out of the Federal Reserve in a long time.”
Markets, however, have become so conditioned to worry about what Fed communications mean for the next rate hike or policy shift that in this case, they may be missing the forest for the trees by ignoring this change in the Fed’s longer-term view.
Fed Chair Janet Yellen, set to speak at the annual Jackson Hole Symposium on Friday, will deliver a speech titled, “The Federal Reserve’s Monetary Policy Toolkit,” which sounds a lot like a speech that will offer a re-think of future policy options.
In a post earlier this month, Ben Bernanke outlined the broad debate happening at the Fed and Neil Dutta, an economist at Renaissance Macro, said in an email this could provide an outline for Yellen’s commentary later this week.
In other words: expect Yellen to go big picture.
Markets, of course, will be parsing Yellen’s speech for clues on whether the next Fed rate hike comes in September, or November, or December, or 2017, or 2018, or not at all.
And make no mistake: the Fed’s target overnight Fed Funds rate does matter. But where the Fed Funds rate settles, at this point in the cycle, is a bit beside the point.
We’ve had interest rates near zero for almost a decade while economic growth has underwhelmed. The time for a new regime is here. Don’t miss it.