Yellen for the most part delivered what we expected – Nomura

Research Team at Nomura, notes that the Yellen gave us a relatively brief description of her views on the “Current Economic Situation and Outlook” (240 words out of a total of 4,000).

Key Quotes

There were few surprises in this part of her speech. She noted that economic growth has “not been rapid.” Nonetheless, “labor utilization” has improved. Looking forward, she expects: “moderate” growth, the labor market to strengthen, and inflation to rise. Based on that outlook she expects that “gradual” interest rate increases will be “appropriate” over time. Last, she said “I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Our expectations for policy are essentially unchanged. We still think that the most likely outcome is that the next hike will come in December. Recent data have been mixed. Activity picked up in June and July. Our Monthly Momentum Indicator was 2.2% in June and July after averaging 1.3% over the preceding six months. Our tracking model for GDP growth in the third quarter implies growth of 2.3%. We are expecting an increase of 200k in nonfarm payrolls for August and a 0.1pp decline in the unemployment rate to 4.8%. On the other hand, consumer price inflation has decelerated somewhat. In addition, other early data for August point to a slowdown relative to activity in June and July.

We are not going to get a lot of additional information between now and the September FOMC meeting. Moreover, some obvious risks will still be outstanding when the FOMC meets next. The US election will still be six weeks away and we are unlikely to know much more about how the British government and its European counterparts are likely to manage the “Brexit” negotiations.

In this context, we think the probability that the FOMC will hike at its next meeting is about 25%, and the probability that the next hike will come in December is about 50%.

In conclusion, Yellen stressed that the FOMC is not actively considering “additional tools and policy frameworks.” However, she also noted that “future policy makers might choose to consider” some additional options. She noted two: purchasing a broader range of assets (which would require legislation); and raising the 2% inflation target or switching to price level or nominal income targeting. In the meantime she said that these alternatives “will be the subject of research and debate”

We see two takeaways from Yellen’s conclusion. First, pushing interest rates negative was not on her list of possible policy innovations. This suggests that she does not think that negative rates are a promising option. Second, the door is open to “research and debate” on the proposal SF Fed President Williams put on the table. We suspect we are going to hear more about these issues in the future.”