Fed Chair Yellen’s testimony confirms that at last the doves are unable to ignore the improvement in the labour market and progress made in getting closer to achieving its dual mandate.
This will now pave the way for the Fed to drop “considerable time” from its statement likely at/before the October FOMC meeting. It would be better to make such a communication shift early as leaving it beyond October could be incorrectly perceived as a signal that there is greater urgency to normalise policy and start the tightening cycle.
The Fed Chair told us that if the labour market “continues” to improve more quickly than anticipated then rate hikes would occur “sooner and be more rapid”. The key word here is “continues” suggesting that the labour market has already surprised the Fed and more of the same data strength will take the Fed closer to achieving their full employment and price stability objectives.
As well as the focus on the labour market, it is also interesting that there is no longer a mention that inflation is low and away from target.
Thus far, the more hawkish minority members of the FOMC (Bullard and Plosser) have been more vocal on the issue of the strength of the economy/labour market, inflation bottoming and attaining objectives. But the shift from Yellen shows that the doves cannot now ignore the evidence and are willing to contemplate the possibility that rate hikes might happen sooner and more rapidly. Payrolls growth averaging over 200k per month and confirmation that inflation (PCE) has bottomed might be enough to start a more active debate over normalising monetary policy.
But first there is the issue of dropping the “considerable time” language. Back in March Yellen suggested that the considerable time between an end to QE and liftoff was something in the order of “around six” months. The semi-annual testimony from Yellen suggests an increased prospect of the Fed meeting its goals earlier than expected and thus greater uncertainty as to the gap between ending QE and liftoff. The data will play a key role in cementing the shift from the doves toward a more hawkish posture allowing for a consensus to build in changing the language.
We continue to favour paying 1y1y USD OIS outright (from 0.72%) and even spreading this against 1y1y GBP OIS as a means of playing for a more hawkish Fed.