Yesterday I wrote about the possibility of Yellen surprising the markets with a conciliatory step towards the hawks at next week’s Jackson Hole Central Banking conference. I highlighted that although I did not think that was the most probable outcome, you needed to be on guard for the possible shift.
I still believe that such a move from Yellen is a possibility (albeit not a very probable one), but today I want to present the other side of the argument – the case for no change in Yellen’s uber dovishness.
Past Fed Chairman Bernanke used the Jackson Hole conference as a policy communication tool, but that was not really the conference’s intended purpose.
The Central Banking conference has been held at Jackson Hole Wyoming since 1981. It was designed as an event where the Federal Reserve members could escape the madness of New York and Washington to debate the finer points of economic policy in peace. It was a place where they could critique each other and present different ideas. At the first conference, Edward Kane presented a devastating critique of Volcker’s tight money policies. During subsequent conferences, other important concepts like whether the Fed should prick asset bubbles were discussed. Apart from being a nice boondoggle for Central Bankers, it was an important forum for them to share different ideas.
In a return to its roots, Yellen’s Fed has rescinded the invitation to Wall Street’s economists. No longer are the economists from Goldman Sachs and Morgan Stanley going to be sharing fish stories with Federal Reserve members. This seems to indicate that Yellen is not planning on using the Jackson Hole conference as a policy communication tool. There would be no sense in not inviting Wall Street, and then using the conference as a way to communicate a shift in policy.
It is not like Wall Street is Yellen’s favourite place anyway. She is rightfully disappointed with the resumption of financial asset bubbles, all the while wage gains by average workers are basically non-existent.
We all know that inequality is rising. Financial assets keep rising, yet labour’s share of the pie keeps falling. Yellen has repeatedly stressed the lack of wage gains as a serious problem. But what is she going to do about it?
At the end of the day, there is only one thing that she can do about it. Her only solution is to leave monetary policy looser for longer. She might try to jawbone down asset markets, but unless she is prepared to raise rates to head off the next bubble, then all it will be is talk.
This is the conclusion that PIMCO’s Paul McCulley so eloquently outlined in his most recent piece – Principled Populism. I have long considered Paul the smartest guy at PIMCO, and I think it is terrific that he has returned from retirement. This article is just another one of the great essays where he clearly articulates the thinking of the Federal Reserve members. You might not agree with it. You might think that this will end in tears even worse than the previous asset bubbles, but it is extremely useful to understand what the Fed is thinking as they walk down this road.
McCulley’s argument is that labour’s share of the economic pie does not really start to increase until the later stages of an economic rebound. Therefore, the best policy for Yellen & Co. to help the average worker is to let the economy rip higher. Allowing the economy to stay in the expansionary stage for longer, will be labour’s best bet at enjoying meaningful wage increases.
Although Yellen doesn’t want a repeat of past financial asset bubbles, she also doesn’t want to snuff out the recovery just when the workers are about to start to enjoy some wage improvements. Therefore, the idea that she will err on moving towards the hawks is probably not in the cards.
There are precious little signals to indicate that Yellen will use the Jackson Hole conference as a platform to shift a little more to the hawkish side. I am not sure if the market will be surprised at her continued dovishness or not. The short end of the bond market seems to have sniffed it out already as those contracts have been rallying for a couple of weeks. Whether the stock market will use her uber dovishness as an excuse to rocket higher or not, I am not sure.