Fed: Larry is getting into the mix - Rabobank

Philip Marey, Senior US Strategist at Rabobank, suggests that while Yellen is optimistic about the longer run prospects for the US economy, she also acknowledged that we cannot rule out the possibility expressed by some prominent economists (of course she means the-man-who-would-be-the-current-Fed-Chairman Larry Summers in particular) that the slow productivity growth seen in recent years will continue into the future.

Key Quotes

“We would like to note that if the ‘secular stagnation’ hypothesis is correct, then the Fed’s current hiking plans will need further downward adjustment. In fact, we could see the Fed take a pause for a sustained period of time.

But for now the FOMC still expects the headwinds, which include economic and financial developments abroad, subdued household formation and meager productivity growth, to slowly fade over time. Thus gradual increases in the federal funds rate are likely to be needed. In line with that view the Committee expects a federal funds rate of less than 1% at the end of this year and less than 2% at the end of next year.

Note that the median of the dot plot published last week was 0.875% in 2016 and 1.625% in 2017. This implies two hikes of 25 bps this year and 3 hikes next year. However, as we pointed out in our FOMC Post-Meeting Comment the distribution around the median for 2016 is now skewed to the downside: while 9 FOMC participants expect two hikes, 6 now expect only one hike. Only 2 expect three to four hikes.

Yellen stressed that considerable uncertainty about the economic outlook remains: domestic demand may falter, China continues to face considerable challenges, a possible Brexit, and abrupt changes in investor perceptions and risk appetite.

While today’s testimony by the Fed Chair supports our view of a September hike - assuming that employment growth will pick up in the coming months-, the risk to our expectation of two hikes before the end of the year (the second in December) is still to the downside.”