The Fed’s R-star gazing - Westpac

Sean Callow, Research Analyst at Westpac, suggests that surely part of the market’s long running fascination with the Kansas City Fed’s annual conference at Jackson Hole, Wyoming is its timing.

Key Quotes

“Being held in late August only increases the anticipation of investors after what is usually a slow month of northern summer vacations, thinning market turnover. While Jackson Hole can be a major event for markets (e.g. Bernanke 2010), more often it passes with little impact. Fed chair Yellen didn’t even attend last year. But her speech on Friday morning local time is the market’s focus. Will this be a game-changer for USD?

The symposium is titled “Designing Resilient Monetary Policy Frameworks for the Future.” In itself, this does not suggest we will receive any guidance over the 21 Sep FOMC decision, currently 25-30% priced for a rate hike. The “future” reference hints at a debate over the Fed’s long term policy stance. As the chart shows, the FOMC has already been rethinking where its tightening cycle is likely to conclude.

The 3% long term funds rate published in June is unlikely to be its resting place for long. Influential SF Fed president Williams argued this month that monetary policy needs to be adaptive. He focused on the “significant decline in the natural rate of interest or r* (r-star)”, or the short term real interest rate that is neither accommodative nor contractionary. Williams says the fall has been driven by “shifting demographics, slower trend productivity and economic growth, emerging markets seeking large reserves of safe assets, and a more general global savings glut”.

Such factors will not reverse any time soon – it is very hard to see the Fed funds rate returning to its pre-GFC 5.25% on any market-relevant forecast horizon. So if the Fed agrees that the economy won’t need much tightening in this cycle, is there any rush to hike again? We suspect there will be no urgency evident in Wyoming this weekend, weighing on USD against most G10 and EM currencies.”