Forex Institutional Research: Deutsche Bank FX Yellen Takes Center Stage
Key quotes from the Deutsche Bank FX Yellen Takes Center Stage report:
Yellen takes Center Stage At Jackson Hole
Fed Chair Yellen’s speech at Jackson Hole should strike a moderately positive tone with respect to the near-term economic outlook. While we do not expect Yellen to explicitly pre-commit to raising interest rates at the September 20-21 FOMC meeting, she will no doubt want to retain the optionality of hiking next month if economic and financial conditions permit.
To be sure, Yellen may couch any potential discussion of the near-term trajectory of interest rates within the context of a significantly lower terminal rate. The topic of this year’s Jackson Hole Symposium is “Designing Resilient Monetary Policy Frameworks for the Future”. Therefore, Yellen’s speech will likely focus on some of the themes outlined last week by San Francisco Fed President Williams.
One implication of a nearzero equilibrium real short-term rate (r*) is that the Fed has very limited room to raise rates, a notion that NY FRB President Dudley recently affirmed. While Williams and Dudley, who are generally viewed as intellectually aligned with Yellen, have each expressed their support for another rate hike, possibly as early as next month, they have also suggested a broader shift in the Fed’s thinking with respect to r*. Fed Vice Chair Fischer also appeared to support another rate hike in the near term when he stated last weekend that “the behavior of employment has been remarkably resilient” despite numerous shocks over the past couple of years. At the same time, Fischer was cautious on the longer-term outlook given the ongoing weakness in productivity growth and low levels of business investment. The point of Fischer’s speech was that the Fed’s mandate is full employment and stable prices, and that monetary policy is not well equipped to address longer-term issues such as productivity growth. In short, similar to the aforementioned comments from other key Fed officials, we anticipate that Yellen’s speech will outline the rationale for taking another step in the policy normalization process, but will also discuss the broader ramifications of a potentially lower equilibrium real rate.
Prior to Yellen’s speech, the BEA will release the first revision to Q2 real GDP. We expect negligible changes to last quarter’s initial growth estimate of 1.2%. However, the same report is likely to show ongoing weakness in corporate profits. Corporate profits in the NIPA accounts have declined in four out of the last five quarters, an extremely rare occurrence outside recession. The weakness in the energy sector and the deleterious effects of a strong dollar have been well advertised. However, as shown in Figure 1, consider the fact that domestic corporate profits (before tax with inventory valuation adjustment) excluding the energy sector and Federal Reserve Banks were still down -5.2% over the four quarters ending in Q1. In our view, this is one the biggest risks facing the labor market. Compressing profit margins, a function of low productivity growth, could eventually weigh on employment and wage growth. Vice Chair Fischer expressed these same concerns last weekend, and Fed Chair Yellen will likely emphasize them as reasons for a very gradual pace of policy normalization going forward.
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