Macro: The Bottom Line (3/24/2014)

Yellen's faux pas

 

Barely two months into the job, Federal Reserve Chair Janet Yellen broke the cardinal rule of central banking: keep your public statements vague. Instead, Yellen gave the clearest indication yet that the first Fed rate hike would come in the second half of 2015. What transpired was a massive bout of bond selling, a surge in Treasury yields, and a strong rally in the US dollar.

The slip of the tongue was related to the issue of when the Fed would hike rates after it had fully "tapered" its quantitative easing. Ever since the FOMC first started to discuss tapering, it had always attempted to reassure markets that reducing purchases wasn't the same as monetary tightening. Or in other words, the end of money printing didn't automatically mean rate hikes. To drive home the point, in every FOMC statement thereafter, it made sure to mention that rates would remain "exceptionally low" for a "considerable amount of time" even after the end of QE. 

Well, how long exactly is a "considerable amount of time"? That's the question that market commentators began to pose in ever increasing numbers, especially as US economic data (recent weather effects notwithstanding) began to point to a robust recovery trend. And at Yellen's first press conference as Fed chair this past Wednesday, one of the reporters had the temerity to pose this question directly to the top. Yellen's response? That "considerable amount of time" would be data-dependent, but would be in the ballpark of six months after tapering is complete. Considering that most expect QE to be wound up by the end of 2014, that would suggest a Fed rate hike as early as mid-2015!

Now, you may be wondering: given that we on Red Bull have been arguing for so long that the era of easy money is not coming to an end anytime soon, isn't this a direct contradiction of our view? Not necessarily. First, for what it's worth, we see Yellen's "six months" as, at best, a rough estimate from a nervous new Fed chair facing reporter questions for the first time. With the press blowing this one line out of proportion, it's easy to forget that the FOMC on the very same day reinforced the message that any rate hike would be dependent on evolving conditions. In other words, even if unemployment is now on the verge of penetrating below the Fed's previous 6.5 percent threshold, should the US economy continue to exhibit imbalances in other areas, the Fed would not hesitate to remain "lower for longer" on rates. And these imbalances are certainly there, from the after-effects of a surge in inventory buildup in 2013, to inflation that remains stuck far below the Fed's very own 2 percent target.

Assuming the Fed remains true to its dual mandate, it's hard to see any rush to the exits by policymakers from their highly accommodative policy. Even if, for a couple of seconds on Wednesday, Yellen seemed to suggest otherwise.