The market had worked itself up into a frenzy before Federal Reserve Chair Janet Yellen’s Jackson Hole speech on Friday
But not unlike the majority of G20 meetings, Yellen’s chat was just a regurgitation of established rhetoric and a lot of hot air. It wasn’t until about 11.30am when Federal Reserve Vice Chairman Stanley Fischer gave his interpretation of the speech to CNBC that markets got spooked.
At 10am (New York Time) on Friday 26 August 2016, Janet Yellen began talking about “The Federal Reserve's Monetary Policy Toolkit: Past, Present, and Future”. In her first paragraph she reiterated the Fed’s current economic view:
“With the U.S. economy now nearing the Federal Reserve's statutory goals of maximum employment and price stability…”
Yellen went on to talk about the positives of the current economic climate:
“U.S. economic activity continues to expand, led by solid growth in household spending […] While economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market.”
Yellen also cautioned:
“But business investment remains soft and subdued foreign demand and the appreciation of the dollar since mid-2014 continue to restrain exports.”
So what does that mean for Fed policy going forward? (emphasis mine):
“Looking ahead, the FOMC expects moderate growth in real gross domestic product (GDP), additional strengthening in the labor market, and inflation rising to 2 percent over the next few years. Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives.”
So far nothing new and these comments are in-line with previous Fed comments. They were relatively dovish compared to what may have been said but then there was this little hawkish kicker (emphasis mine):
“Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”
As is almost mandatory when Yellen talks about monetary policy the usual data dependency caveat was quickly attached:
“Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee's outlook. And, as ever, the economic outlook is uncertain, and so monetary policy is not on a preset course.”
For anyone looking for further clues about timing of the next hike in the speech, there weren’t any. However it was a nerdishly interesting insight into the Central Bank’s thinking on its monetary policy tools to deal with another economic crisis.
For those that care, Yellen’s view is that while additional tools – such as raising the Fed’s 2% inflation objective or targeting a price level or nominal GDP target – may be considered, she believes that even if interest rates remain low, existing monetary policy largely driven by the Fed fund rate will “under most conditions, be able to respond effectively.”
What was also of interest was the wide-range of FOMC members’ Fed funds rate projections that is contained in this next chart. A couple points are worth noting – there is still a wide variance within the 70% confidence level and the lower line does not fall below zero:
Market reaction
Given investors quite rational concern that Yellen may have used this as an opportunity to further establish September as a ‘live’ meeting, it should come as no surprise that after an initial head fake to the hawks, US Treasuries rallied (yields fell), the USD weakened and equities rallied. This is illustrated in the four Bloomberg charts below; Yellen started speaking at 10am, which is the vertical line in the charts.
UST 2yr yields – intraday Friday 26 August 
Source: Bloomberg
UST 10yr yields – intraday Friday 26 August 
Source: Bloomberg
AUD:USD – intraday Friday 26 August
Source: Bloomberg
US equity markets – intraday Friday 26 August 
Source: Bloomberg
As can be seen in the above charts, the market reaction was relatively muted until about 11.30m (New York time) when Fed Vice Chair Fischer began his interview on CNBC.
Fischer initially stuck to the playbook, noting that the US economy had strengthened over recent months, with it close to full employment and inflation edging slowly higher. Fischer observed that the majority of the most important data points had been better than expected and shrugged off the weak Q216 GDP print as backward looking and susceptible to revision.
Fischer finally acknowledged that Friday’s NFP print would help the Fed make its decision in September.
Then there was the unexpected bombshell, as Fischer ripped up the playbook and fumbles the ball. In answer to the question, “Is September a ‘live’ meeting and could the Fed hike twice before the end of 2016?” Fischer not only said yes to both but also stated that Yellen’s speech was consistent with that view. Fischer did emphasise that the Fed’s move was data dependent but at that stage the damage was done and no one was listening.
Fischer’s remarks were enough to send the hawks swooping and the doves scooting for cover; USTs reversed initial gains as yields rose, the US dollar appreciated and equities fell.
Conclusion
The Fed keeps positioning the market to expect higher rates soon but doesn’t seem brave enough to pull the rate hike trigger. Even after Fischer’s hawkish comments, the market continues to believe that it is about an even chance of only one hike by December.