Fed to be more hawkish than justified?
July 26, 2017

As the latest FOMC (Federal Open Market Committee) meeting takes place, Jean-Paul Jaegers, senior investment specialist at PPMG, offers his thoughts.

"A lot has been written on the recent softness in US inflation data, as headline inflation pulled back, with a similar trend in core inflation. Admittedly a number of unusual factors have been partly a driver behind this, although more importantly there is quite some persistence in the broad-based softness.

"As a result, in recent communications by the Fed (more specifically by Chairwoman Janet Yellen) the uncertainty in the outlook for inflation was highlighted and that only part of the recent softness in inflation was deemed transitory. Interestingly, we also notice in the Fed communications there is more and more reference to ‘financial conditions' and this is important.

"The policy rate set by the central bank is not directly impacting the economy, but indirectly. However, financial conditions, for example measured by the Chicago Fed in the National Financial Conditions Index (NFCI) signifies significant easing so far year-to-date.

"This NFCI index which comprises exchange rates, various interest rates, money markets, credit markets and equity volatility, amongst others, are all directly linked to ‘financial' conditions in an economy.

"Recent Fed minutes have been referring to a few FOMC members being more worried about risks to financial stability, and easier financial conditions may potentially encourage the Fed to lean a bit against asset price bubbles (think practically about ‘being less encouraged to pause or sound dovish').

"Central bankers have made relatively explicit statements that as financial conditions have become easier, policy needs to be tightened to stand still. This would be an important nuance as a continuation in easing of financial conditions (ie lower US dollar, higher equity prices, lower interest rates, etc.) could potentially strengthen the case for a continuation in tightening either via policy rate or balance sheet adjustment.

"Thus if the Fed were to start focusing more on financial conditions and financial stability, it may potentially sound more hawkish than inflation data/dynamics would suggest."





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As the latest FOMC (Federal Open Market Committee) meeting takes place, Jean-Paul Jaegers, senior investment specialist at PPMG, offers his thoughts.

"A lot has been written on the recent softness in US inflation data, as headline inflation pulled back, with a similar trend in core inflation. Admittedly a number of unusual factors have been partly a driver behind this, although more importantly there is quite some persistence in the broad-based softness.

"As a result, in recent communications by the Fed (more specifically by Chairwoman Janet Yellen) the uncertainty in the outlook for inflation was highlighted and that only part of the recent softness in inflation was deemed transitory. Interestingly, we also notice in the Fed communications there is more and more reference to ‘financial conditions' and this is important.

"The policy rate set by the central bank is not directly impacting the economy, but indirectly. However, financial conditions, for example measured by the Chicago Fed in the National Financial Conditions Index (NFCI) signifies significant easing so far year-to-date.

"This NFCI index which comprises exchange rates, various interest rates, money markets, credit markets and equity volatility, amongst others, are all directly linked to ‘financial' conditions in an economy.

"Recent Fed minutes have been referring to a few FOMC members being more worried about risks to financial stability, and easier financial conditions may potentially encourage the Fed to lean a bit against asset price bubbles (think practically about ‘being less encouraged to pause or sound dovish').

"Central bankers have made relatively explicit statements that as financial conditions have become easier, policy needs to be tightened to stand still. This would be an important nuance as a continuation in easing of financial conditions (ie lower US dollar, higher equity prices, lower interest rates, etc.) could potentially strengthen the case for a continuation in tightening either via policy rate or balance sheet adjustment.

"Thus if the Fed were to start focusing more on financial conditions and financial stability, it may potentially sound more hawkish than inflation data/dynamics would suggest."



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