Four Fed hikes isn’t set in stone

Remarks by Fed officials at the symposium in Jackson Hole, Wyoming, confirmed the consensus market expectation that the US central bank will hike interest rates two more times this year, delivering the biggest annual tightening in more than a decade.
The increases would be carried out even as the Fed is reducing the size of its $4 trillion balance sheets. Yet, judging from the most important signal, the headline speech by Chairman Jerome Powell, this path may be far from set in stone.
There are two good reasons why market participants have paid so much attention to the annual gathering of domestic and foreign central bankers. First, some Fed chairs have used the venue to signal major policy initiatives (as Ben Bernanke did in 2010, with the second round of quantitative easing). Second, the forum allows media unusually good access to central bankers.
Last week, the majority of Fed officials interviewed reinforced the notion that the Fed will raise interest rates in September and December. This message was bolstered by Powell, who indicated that “further gradual increases in the target range for the federal funds rate will likely be appropriate.”
This strengthening of the prior policy signal took place against backdrop of what Powell briefly alluded to as “risk factors abroad.” But the Fed chief chose to emphasize the strongly expanding US economy. “With solid household and business confidence, healthy levels of job creation, rising incomes, and fiscal stimulus arriving, there is good reason to expect that this strong performance will continue,” he said.
These markers point to unemployment and inflation at levels consistent with the Fed’s targets and sustainable economic growth, notwithstanding some recent weakness in the housing and auto sectors. Yet it is only a matter of time before these vulnerabilities are perceived to be spreading by those who incorrectly see the continuously flattening yield curve (the differential between two-year and 10-year bonds reached 19 basis points last week) as an indication that a major economic slowdown is approaching.
Although earlier this year many embraced the prospect of a synchronized global pickup, growth paths have diverged as uncertainty has gained in Europe and China. The currency crisis in Turkey is far from over, especially because the government continues to rule out the use of two important policy tools (interest rates and intervention by the International Monetary Fund). Meanwhile, the renewed decline of emerging-market currencies last week imperils countries with considerable foreign-exchange mismatches and large immediate funding needs.
Then there are the many US domestic economic puzzles that Powell covered in his speech. The structural uncertainties that underpin the need for what he called a “risk management strategy” are linked to a relatively long list of issues, including wage and productivity behavior, technological innovations, the international trade regime and the impact of changing demographics and fiscal impulses.
Another factor is the uncertainty Powell has mentioned in the past, but dealt with only in passing this time under the rubric of “destabilising excesses.”
All of this indicates that, beyond September, the prospects for monetary policy could become increasingly uncertain. No matter how confident several of the regional bank presidents appeared at Jackson Hole, there is a growing set of legitimate domestic and external questions that influence what the Fed will end up doing in December, let alone next year.

— Bloomberg

Mohamed A. El-Erian is a Bloomberg Opinion columnist. He is the chief economic adviser at Allianz SE, the parent company of Pimco, where he served as CEO and co-CIO. His books include “The Only Game in Town” and “When Markets Collide.”