Eric Rosengren may have been outvoted on Wednesday last week, but he is not going to roll over quietly. In a statement released on Friday, the Boston Fed president noted that the US economy has faced significant external headwinds. Notwithstanding these challenges, the US has still managed to add over 1.4m jobs this year. Raising rates now would extend the economic recovery: the Fed could “continue testing to find the level of full employment – but gently, not sharply”.
Ms. Yellen, by contrast, is persuaded by the rise in the participation rate, which is preventing any “overheating”. The pace of rate hikes over the coming year will be determined largely, if not entirely, by wage inflation. As Ms. Yellen indicated clearly last week, it will not be driven by issues around financial imbalances or asset valuations. Not having to raise interest rates to tackle leverage is a positive for stock markets. The FOMC may be split over how to interpret the labour market data, but this will be much less of a problem for equities. Even if Mr. Rosengren is right, the strong pace of innovation has flattened the Phillips Curve. The path of rate hikes is still likely to be shallow.
Summary:
- Shallow path of rate hikes
- Fed has array of ‘tools’ to mitigate financial stability risks
- But uptick in wages would favour hawks: Yellen needs to strengthen her counterargument
