Last week investors got some insight into the future of the Fed with Janet Yellen at the helm. She testified before the Senate Banking Committee, fielding myriad questions from lawmakers on the economy, the stock market, jobs and monetary policy. And investors clearly liked what they saw, with stocks rising on Yellen-induced euphoria.
“The possibility of a December 2013 taper, which had increased on the heels of stronger-than-expected jobs data, is now highly unlikely after Yellen’s testimony.”
Here are our key takeaways:
The Fed will start tapering in March 2014 at the earliest. The possibility of a December 2013 taper, which had increased on the heels of stronger-than-expected jobs data, is now highly unlikely after Yellen’s testimony. Investors should plan for easier monetary policy for longer.
The Fed remains committed to transparency. Yellen signaled a commitment to continued transparency for the FOMC. She cited her role in the FOMC’s adoption of a statement on its longer-run objectives, including a 2% goal for inflation. She believes that establishing a target tied to forward guidance “sent a clear and powerful message about the FOMC's commitment to its goals.” She also conceded that the Fed’s communications are imperfect, that they’re “a work in progress, and sometimes miscommunication is possible.” She appears interested in reducing volatility by improving communications, but keeping them transparent.
The Fed is steadfast about maintaining its independence. Yellen stressed the importance of the Fed’s independence, which has come under fire recently with some lawmakers calling for greater oversight of the central bank.
The Fed sees significant flaws in the economic recovery, particularly in the labor market. Yellen believes that, in many areas, the economy hasn’t returned to its pre-Great Recession levels. Specifically, Yellen voiced a concern that we also share: the number of Americans who have been out of work for a long period of time, or the “persistently unemployed,” remains elevated. That’s one of the reasons the Fed must maintain a highly accommodative monetary policy, she said. And her comments could be a sign that the Fed is considering lowering its unemployment target.
Expect monetary policy to help combat fiscal spending cuts. Yellen recognized that the reduction in government spending has hurt the economy, but she noted that dovish monetary policy has helped offset spending cuts.
When tapering begins, QE of MBS may continue. Yellen highlighted how low interest rates have boosted the housing recovery, a trend that’s been “broadly beneficial” for the economy. This is consistent with research conducted by economists Karl Case, John Quigley and Robert Shiller, which shows that home prices have had a greater impact on the wealth effect than stock prices. It also syncs with Arvind Krishnamurthy’s paper released at the Fed’s meeting at Jackson Hole, “The Ins and Outs of LSAPs,” which asserts that buying mortgage-backed securities has been more economically impactful than buying government securities. Given this sentiment, the Fed may continue MBS purchases even after it begins to taper government securities purchases.
The Fed has a third objective. Yellen reinforced the idea—one she presented back in September when she was nominated—that there is a third objective for the Fed beyond maximizing employment and maintain price stability. It’s maintaining stability in the financial markets. This suggests a broad mandate for the Fed. It could also mean that tapering, because of its potential to destabilize markets, could be more gradual under Yellen’s FOMC.
The Fed’s likely to keep QE in place longer. Yellen said that she sees the benefits of highly accommodative monetary policy outweighing the costs right now, given that 1) she believes the economy still needs help and 2) she doesn’t believe any major asset bubbles have been created at this time.
Yellen’s remarks reinforce our view that the Fed is an activist institution that’s fast becoming the fourth branch of government in the United States. In her testimony, Yellen offered a broad interpretation of the Fed’s responsibilities, stating that the objective of Fed policy "is to broadly benefit all Americans." Stay tuned for more insight as we get to know Janet Yellen better in future hearings.
Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors.She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.
Past performance of the markets is no guarantee of future results. This is not an offer or solicitation for the purchase or sale of any financial instrument. It is presented only to provide information on investment strategies and opportunities.
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