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Economic Outlook - AUGUST 2016

Measures of volatility in the U.S. stock and Treasury markets ebbed lower in August while awaiting Fed Chair Janet Yellen’s speech at the Kansas City Federal Reserve Bank’s annual symposium in Jackson Hole, Wyoming. Her address came after comments by Vice Chairman Stanley Fischer and other Fed colleagues indicated that interest rates may still rise in 2016. Leading up to her speech, mixed data indicated the U.S. economic recovery is on relatively solid ground with the labor market approaching full employment. However, according to the minutes of the July FOMC meeting, low inflation, low expectations for inflation, and disinflationary impulses from abroad have shaken the confidence of some Fed officials about reaching the targeted 2 percent inflation rate. Those same minutes also indicated that a couple of FOMC members appeared ready to raise rates at that meeting, highlighting the divergence of views among policy makers.


In the highly anticipated speech on August 26th, Yellen gave a balanced but mostly upbeat view of the economy. Some of her remarks follow:

“U.S. economic activity continues to expand, led by solid growth in household spending. But business investment remains soft and subdued foreign demand and the appreciation of the dollar since mid-2014 continue to restrain exports. While economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market. Smoothing through the monthly ups and downs, job gains averaged 190,000 per month over the past three months. Although the unemployment rate has remained fairly steady this year, near 5 percent, broader measures of labor utilization have improved. Inflation has continued to run below the FOMC’s objective of 2 percent, reflecting in part the transitory effects of earlier declines in energy and import prices.

“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. 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. Of course, our decisions always depend on the degree to which incoming data continues to confirm the Committee’s outlook.” 


With policy makers assessing data to guide their rate decisions, the results of the August jobs report, due the first Friday in September, may determine if the Fed moves rates higher as soon as the September FOMC meeting. Contained in her speech was cautious language about the level of equilibrium or neutral interest rates which might signal a flatter path for rate increases in coming years, but doesn’t stand in the way of a hike in the near-term, although nothing she said points to imminent action. The equilibrium or neutral rate is defined as the rate of interest at which there is neither upward nor downward pressures on inflation, i.e., stable prices.

In the wake of Yellen’s speech, the bar for the Fed to increase rates in 2016 has probably been lowered. Even so, the Fed will likely remain cautious, fearing the risk of moving too quickly could have detrimental implications for global growth and financial markets. Additionally, with a growing belief among policy makers that ageing populations, declining productivity, and below-target inflation rates are likely to result in lower peaks in policy rates suggests the Fed can still be patient. Whether the Fed hikes in September or waits until December, after the national elections, the byword will be caution and the path will likely be low and slow from here.