When Janet and Mario come to town: what to expect from Jackson Hole

The first time Janet Yellen went to Jackson Hole as Federal Reserve chair in 2014 she faced activists protesting against the prospect of interest rate rises. This week the tone in Wyoming will be different. Campaigners from the same group - Fed Up - will be agitating for her reappointment to the post.

The reason is clear: the Fed chair’s campaign to tighten policy has been an extraordinarily benign one. Financial conditions are looser today than they were when the Fed first lifted rates at the end of 2015 as equities have surged and bond yields have sunk. Unemployment has fallen to a little over 4 per cent from crisis-era highs of 10 per cent, growth is tepid but steady, and wages are rising faster than inflation.

Shawn Sebastian of Fed Up declares Ms Yellen one of the most successful Fed chairs ever - even if he insists the Fed was wrong to be contemplating further rate rises. "For most of her tenure she was fighting back hawks to stimulate the economy and keep rates low, and as a result millions of jobs were created."

Not all testimonies will be as glowing as Mr Sebastian's. As Ms Yellen prepares for what may be her final Jackson Hole as Fed chair, Donald Trump has been considering whether to install a new central bank chief. Among the question marks hanging over her record: even as the Fed repeatedly fails to achieve its inflation mandate, it is also presiding over a resurgence in asset prices and investor risk-taking that is making some investors and policymakers anxious.

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Their unease is understandable, given that the recessions of recent decades have been preceded by asset booms and busts - triggering harsh criticism of the Fed. "It is impossible not to have concerns when looking back at previous instances," says Tim Duy, a professor at the University of Oregon and Fed-watcher. "We should be cognisant of our history so we don't repeat it."

Asset valuations

At its last meeting, officials' assessment of the vulnerabilities linked with high asset valuations rose to "elevated". Stanley Fischer, the Fed's vice-chair, said this month he did not understand why equity prices had continued to surge, and that this made him uncomfortable - especially when the hopes of Republican tax reforms that had helped drive equities higher had been fading.

Ms Yellen will tackle this financial stability issue directly in her conference speech, Fostering a Dynamic Global Economy. The likelihood is that she will strike a broadly sanguine note on Friday.

There are a number of likely strands to this discussion, says Roberto Perli of Cornerstone Macro. First, Fed officials argue that the dramatic strengthening of capital standards in the banking sector since the crisis should reduce the risks of broad economic damage if there is a big sell-off in asset markets - in contrast to the situation during the financial and property crash of 2007-09.

The question underlying that discussion is whether bigger risks are lurking outside the formal banking sector - and whether Republican efforts to loosen bank regulation will go too far.

At the same time, the Fed remains reluctant to use the blunt tool of interest rate rises to stem rocketing asset valuations. The orthodoxy at the central bank remains that regulatory tools are a better means of targeting any vulnerabilities - although this argument is undercut by the relative paucity of alternative tools in the central bank’s arsenal.

On the other hand, senior Fed officials, led by Bill Dudley of the New York Fed, argue that highly supportive financial conditions are a reason to continue lifting interest rates, even in the face of five years of below-target core inflation readings. If Ms Yellen were to make that link as explicit as him, markets would take it as a hawkish signal against doves focused on below-target inflation.

Mario Draghi

The other main market-moving event at Jackson Hole is a speech on Friday from Mario Draghi, European Central Bank president. With the ECB expected to decide in the autumn on slowing its pace of purchases in 2018 from the current €60 billion a month, markets hope the ECB president will drop some hints on what form that tapering will take.

Mr Draghi looks set to say little about what will come next, although he has changed his speeches at the last minute.

For Ms Yellen, the most imminent policy step is likely to be the announcement at the Fed's September meeting of a start date to the process of unwinding the Fed's $4.5 trillion asset portfolio. Robin Brooks, chief economist at the Institute for International Finance, said if she calls the start of the process then it would allow her to declare "mission accomplished", putting the job of unwinding quantitative easing on to autopilot.

If she achieves that without upsetting markets, it will be another sign of her ability to rein in Fed stimulus as uneventfully as possible. The question is what risks are brewing beneath the surface.

Copyright The Financial Times Limited 2017