On one hand, every economist, virtual portfolio manager, Yahoo Finance Twitter expert, and TV talking head is certain that a September rate hike is inevitable.
On the other hand, the bank that runs the NY Fed (and whose chief economist Jan Hatzius has dinner with NY Fed head Bill Dudley at the Pound and Pence every other month), Goldman Sachs is doubling down on its call that the Fed will not hike in September.
We’ll go with Goldman (only because in this case it really is a dumb vs dumber moment).
Incidentally, here is Hatzius in January 2014 predicting “above-trend growth” for the US (and “for what it’s worth”, Joe Wisenthal naturally agreeing with him).
So here, without further ado for those who still care about this most farcical of discussions, is Goldman’s Jan Hatzius with seven reasons why Yellen will delay. Again.
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From Goldman’s Jan Hatzius
Shouldn’t Be Close
1. We do not expect a rate hike at the September 16-17 FOMC meeting. This call was originally based on our interpretationof the June “dot plot” and Chair Yellen’s July 10 speech, which suggested to us that her own expectation was liftoff in December, not September. If this interpretation was correct at the time, and if we are right in assuming that Yellen’s views are ultimately decisive, the key question is how the economy and the financial markets have performed relative to her expectations of 2-3 months ago. If developments have beaten her expectations, it is possible that she might now support a hike. In contrast, if developments have been in line with or weaker than her expectations, she will presumably resist a hike.
2. Even if we focus only on the economic data, it is difficult to argue that developments have beaten expectations. Although growth has been decent and the labor market has improved further, both wage and price inflation have fallen short of consensus expectations. Our wage tracker stands at just 2.1% as the Q2 employment cost index surprised on the downside, and core PCE inflation just made a four-year low of 1.24%. Moreover, the notion that the weakness in core inflation is principally due to the temporary effects of a stronger dollar and lower commodity prices does not look right; core PCE goods inflation, where such effects should be concentrated, is only 0.4pp below its 20-year average, a gap that is worth just 0.1pp for the overall core PCE index. This suggests that most of the inflation shortfall relative to the Fed’s 2% target is due to more persistent factors, including continued labor market slack.
3. Once we broaden the perspective to include financial markets, developments have been substantially worse than almost anyone expected in June or early July, leading many forecasters (ourselves included) to shave their expectations of future growth. Our GS Financial Conditions Index (GSFCI) is at the tightest level since 2010, as the dollar has appreciated further, credit spreads have widened, and stock prices have fallen substantially. At this point, our “GSFCI Taylor rule” suggests that actual financial conditions are much tighter than the level suggested by the current levels of employment and inflation relative to the Fed’s targets. In a similar vein, market inflation expectations have fallen back to the lows of early 2015; the five-year five-year forward TIPS breakeven stood at 1.88% on Friday, which we think is consistent with a market expectation for PCE inflation of just 1½%, half a point below the Fed’s target.
4. So how do we explain Vice Chairman Fischer’s relatively hawkish CNBC interview and speechat the Jackson Hole symposium? While Fischer did not comment directly on the timing of liftoff, he did provide a fairly upbeat interpretation of the labor market and inflation picture, which many have interpreted as a signal that he will support a hike on September 17. However, an alternative interpretation is a desire to avoid pre-empting the actual FOMC meeting, at a point in time when the market-implied probability of a September hike stood below 25%. In support of this interpretation, we would note that Fischer also gave a speech widely interpreted as hawkish just three weeks before the March 17-18 FOMC meeting, which featured sizable downward revisions to the committee’s inflation and funds rate paths.
5. There are also some logistical difficulties with a hike on September 17. Right now, the market-implied probability of a hike is 30%-35%. We believe that the FOMC will want to be reasonably sure that the first rate hike in nearly a decade is well anticipated by the market on the day it occurs. This implies that a strong signal between now and the meeting may be necessary to put the committee in a position where it feels it actually can hike without potentially causing a significant amount of market disruption. But again, the desire to avoid pre-empting the discussion at the meeting itself presumably argues against sending such a signal. The path of least resistance is therefore to wait, which might mean that the market-implied probability of a hike on the day of the meeting itself will be close to current levels. If so, we think that market pricing in itself would become a strong argument around the FOMC table against pulling the trigger on September 16-17 [ZH: which means that as many have suggested, it is the market’s tantrums and not the Fed, which calls the shots].
6. If we are right about the will-they-or-won’t-they issue, the next question is what message the committee will send about future policy on September 17. On this, it is harder to be confident. The tightening of financial conditions has greatly strengthened the case of commentators such as former Treasury Secretary Summers that the committee should not be signaling a 2015 liftoff; taken literally, our GSFCI rule implies that the committee should be looking for ways to ease, not tighten, policy. And the simplest way to do that would be to signal a later liftoff than the market is currently discounting. Against this, many meeting participants will argue that the tightening of financial conditions could reverse quickly and a 2016 liftoff is too late given the further improvement in the labor market and the sharper-than-expected decline in the headline unemployment rate in recent months. In the end, our baseline expectation is that the message from the meeting, including the “leadership dots”, will remain broadly consistent with liftoff in December but Chair Yellen will make it clear in the press conference that financial conditions need to improve for the committee to actually hike this year.
7. Other aspects of the meeting are also likely to be mostly dovish. Although the unemployment rate path will once again have to come down, we expect this to be largely offset by a reduction in the committee’s estimate of the structural unemployment rate. The forecasts for real GDP growth, inflation, and the longer-term funds rate are also likely to decline modestly. That said, the Fed’s funds rate expectations are likely to remain well above the distant forward rate, which now suggests a market view of the equilibrium funds rate of just 2%. We agree with the Fed’s view that this is likely too low, although the question will not be definitively settled for several years.
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