Updated: 08-22-2016

Yellen's Speech to Set Course for Fed, Money Market Fund Reforms Loom
Updated: 19-Aug-16  05:11PM ET
Analyst: David Kelland

The problem with Fed speakers is that it is difficult to mentally handicap their public statements. We hear 20 times as much from somebody like San Francisco Fed President Williams as we do from Fed Governors Brainard or Tarullo, but the latter two both vote on rate decisions and Williams does not. We cannot even reliably use the frequent speakers as representative of the whole FOMC because somebody like St. Louis Fed President Bullard went from hawkish to dovish in about six months while Williams was going in the other direction. Fed Chair Yellen's speech this coming Friday is supposed to unleash some sunlight to burn off the fog surrounding the future path of Fed policy. We shall see.
The July FOMC minutes, released on Wednesday, showed that several participants thought the committee would have time to react to a sharp uptick in inflation. In that group, I would hazard to say are Fed Governors Brainard, Tarullo, and Powell plus St. Louis Fed President Bullard. Brainard and Tarullo, especially the latter, are in the camp of waiting to see the whites of inflation's eyes before hiking. If you read Tarullo's interview with Jon Hilsenrath of the Wall Street Journal on July 6*, you see a policymaker who will be highly encouraged by the weak July PPI and CPI data to keep rates on hold. His argument in that interview, and that of many saltwater economists, is that if we're bringing people back into the workforce without a large buildup in debt-financed speculation, why hike rates? Brainard was the first one to question the usefulness of the Phillips Curve in 2015, and she can be expected to agree with Tarullo.

On the other hand, New York Fed President Dudley said this week that September is in play. Boston Fed President Rosengren said back on May 12 that the market was far too optimistic about easy Fed policy, so he could easily go along for a hike given two straight months of 250K+ nonfarm payroll growth. Mester and George are even more hawkish and would also go along with tightening. 

So the way I have them lined up, Yellen and Fischer are the swing votes for September Fed funds futures currently indicate an 18% probability for a September rate hike, according to the CME website.

In economic data, the news this week was balanced to the upside. The New York Fed's Nowcast model forecast for Q3 U.S. GDP growth rose to 3.0% this Friday from 2.4% last week. Growth in industrial production and capacity utilization in July were the biggest contributors to the upward revision. 

There are other things going on that bear watching as well. Money market fund reform is set to be implemented on October 14. According to the Financial Times:

Over the next six months, funds will continue to prepare for October 14, when full implementation of the rules is required. At that point, prime funds will be required to publish net asset values based on the current value of the assets they hold. That is a big departure for an industry that historically has touted its ability to preserve the value of its investments at $1 a share, and will mean a fund's price will fluctuate along with market conditions.

Also from October, if the fund's assets that can be liquidated within one week fall below 30 per cent the fund can impose a fee of up to 2 per cent on redemptions. If that falls below 10 per cent they can impose a fee of 1 per cent. The fund could also prevent redemptions completely for up to 10 days if the 30 per cent threshold is breached. 

These upcoming changes have caused commercial paper yields to rise and some analysts are saying that the reforms are having the same effect as an interest rate hike. Given the record of the Fed embracing one-off events to delay its path of policy normalization, tightening in short-term debt markets could be the next big excuse. To clarify, however, I still see a rate hike by year-end and long-term Treasuries as misaligned with fundamentals. 

- David Kelland, Briefing.com

* http://www.wsj.com/articles/transcript-q-a-with-fed-governor-daniel-tarullo-1467847300

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