20:40 GMT +318 January 2020
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    In a speech, Fed Chair Janet Yellen inadvertently advocated a set of policies that imply lower interest rates and other accommodative measures, possibly hinting at negative rates looming as a recession-aversion strategy.

    Kristian Rouz – Federal Reserve Chair Janet Yellen delivered a speech on Friday, having said that creating the policy conditions for a “high pressure economy” would be the only way to avoid a recession.

    Certain market participants suggested that the regulator will abstain from a further tightening of monetary conditions. Specifically, JP Morgan said they are still expecting a December hike; the tone of their message seemed to imply that they were urging the Fed to move rates up.

    Meanwhile, in her speech, Yellen said additional measures to stimulate the economy might be necessary, such as higher inflation targeting, having hinted at “helicopter money” as a possible solution as well. The Fed Chair’s message also fueled expectations of a possible negative interest rate policy (NIRP), which could be implemented as the economy keeps faltering just above zero growth.

    Although Yellen put forth very few straightforward suggestions for future policy during her speech, her overall message was very dovish. The Fed Chair repeatedly said that “all (Fed) meetings are live,” and said the word “recession” over 20 times. Market participants and observers, however, focused on her suggestion that “high pressure economy” conditions would be beneficial for growth – with the term itself referring to a greater amount of monetary easing, contradicting the Fed’s current set of policies.

    “If we assume that hysteresis is in fact present to some degree after deep recessions, the natural next question is to ask whether it might be possible to reverse these adverse supply-side effects by temporarily running a 'high-pressure economy,' with robust aggregate demand and a tight labor market,” Yellen said.

    By saying “adverse supply-side effects”, the Fed Chair referred to the current decline in corporate earnings, lackluster levels of investment, a slump in business activity and overall private sector weakness.

    “With … interest rates at or close to their effective lower bound in many countries … many central banks have sought additional ways to stimulate their economies, including adopting policies that are directly aimed at influencing expectations of future interest rates and inflation,” Yellen said, reiterating her earlier thoughts voiced during her Jackson Hole speech several weeks ago that first sparked concern that additional monetary policy tools, such as “helicopter money” or negative rates, might be implemented soon.

    Addressing the concern of why the currently tight labor market conditions have failed to produce  stronger inflation and economic growth sustainable enough to normalize monetary conditions, Yellen admitted that “the influence of labor market conditions on inflation in recent years seems to be weaker than had been commonly thought prior to the financial crisis.”

    “The underlying cause is unknown,” Yellen said.

    The speech sent several disturbing signals to the market. First, the Fed does not have a clue of what is going on, let alone how to fix it. Second, central bank liquidity injections might be a possibility in the near future – again, but this time not in the form of “quantitative easing” in bond buyouts, but as “helicopter money”, or targeted inflows of Fed money into certain struggling sector of the economy.

    Third, the Fed can’t raise rates further, and might even roll them back to zero or below. The term “high-pressure economy” is explained in a 2015 paper by the Center on Budget and Policy Priorities as follows.

    “Damage to the US economy that, in the absence of strong monetary stimulus, is likely to persist indefinitely … can be reversed to a substantial degree by expansionary monetary policy. Expansionary policy can create … a “high-pressure economy,” one with stronger-than-average economic growth and low unemployment.

    The Fed should do everything it can to promote a high-pressure economy, not increase interest rates and choke off growth as soon as inflation threatens to rise.”

    Therefore, Yellen’s use of such terminology suggests she is willing to do “everything … to promote” inflation, and the only way to do it is relaxing monetary conditions within the current framework of broader economic policy. “Not increasing” rates and “choking off” growth, which is sluggish at around 1pc year-on-year, fall in line with this approach, implying a possible introduction of negative rates (NIRP).

    Signs of anxiety in the US market were revealed very quickly after Yellen’s speech. Micheal Feroli, JP Morgan's chief US economist, said that “we continue to expect the next hike in December.”

    “First, she (said) a 'high-pressure economy' could help the supply side, such as stimulating greater capex, R&D, and labor force participation. Second, she stressed the role of monetary policy in anchoring inflation expectations. Third, she stated that easy monetary policy in the US is beneficial to growth overseas, arguably a good thing,” Feroli explained, adding that “Some of these themes are contested. Most notably, the argument that monetary policy can foster supply side gains.”

    The view reflects the market participants being fed up with the loose monetary conditions that have failed to produce any substantial growth in the current environment. A supply-side reform would require a lot more than tweaks in monetary policies that could only accompany a structural reform, likely going up, not down as hinted by Yellen.

    However, a cut in interest rates to below zero could win the establishment in Washington some more time before the current stalemate resolves in a new recession and economic crisis.


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