- Five Takeaways From Janet Yellen’s Testimony
Janet Yellen’s first day testifying before Congress solidified investor views that the Fed chair is more hawkish, building on sentiment from the most recent Federal Reserve meeting and pushing Treasury yields higher.
Here are five takeaways from her appearance before the Senate and ahead of a second day of testimony and questions on Wednesday before the House of Representatives.
Hawkish sentiment continues
Ms Yellen echoed some of the language from the Fed’s last policy meeting, providing further evidence that the US central bank has adopted a more hawkish outlook in recent months. But she left some wiggle room for how the policies of President Donald Trump’s administration will develop from ideas to reality.
The dollar climbed off the back of her testimony, trading up 0.27 per cent at 101.230 in the New York afternoon, having sunk slightly in early morning trading. US Treasury yields rose, with the benchmark 10-year note moving 6 basis points higher before edging back to 2.47 per cent. The 5-year Treasury, sensitive to the future path of interest rates, rose 4.5bp to 1.96 per cent.
Stock markets recovered from a soft morning and the S&P 500 closed 0.4 per cent higher at 2338, led by the financial sector.
“Clearly, Chair Yellen does not want to be labelled as the ‘dove who is behind the curve’ and her measured approach has acknowledged that inflation is reaching the Fed’s two per cent desired level and she, along with her colleagues, are prepared to view each meeting as live,” said Quincy Krosby, market strategist at Prudential Financial.
Markets price in June rate rise and elevate expectations for March
Some analysts suggested that Ms Yellen’s testimony represented a tacit acknowledgment that the Fed may have been behind the curve in raising its policy rate, or that it is at least concerned about the possibility of holding off for too long.
“Waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession,” said Ms Yellen.
Markets quickly began repricing expectations of future rate increases. Odds that the US central bank will tighten policy by 75bp this year — through three 25bp shifts — increased to 34 per cent, according to calculations on federal funds futures.
That was up from 30 percent immediately before her speech and as low as 24 per cent earlier this month when lacklustre wage gains were interpreted by some investors as releasing the pressure on the Fed to tighten policy imminently.
The market is now fully pricing in the next rate rise in June, followed by a second in December. That compares with policymakers’ own projections last year for three 25bp increases.
“We think the Fed may come to increasingly recognise that it has been behind the curve during this hiking cycle and what the risk markets may not be fully appreciating is an acceleration in rate hiking,” said Rick Rieder, chief investment officer of global fixed income at BlackRock.
Agreement with Mr Trump’s core principles on financial regulation
Ms Yellen said she supported the core principles of Mr Trump’s recent executive order on financial regulation. The order, which outlined plans for a review of existing rules, also put forward a set of core principles that the US regulatory system should look to espouse, such as preventing taxpayer funded bailouts and making regulation “efficient, effective, and appropriately tailored”.
“I certainly do agree with the core principles,” said Ms Yellen. “They enunciate very important goals for our financial system and supervision and regulation of it.”
Financial stocks rallied on Tuesday, with the sector leading the S&P 500 index in the New York afternoon, up 1.23 per cent.
But Ms Yellen did caveat her remarks in response to some senators’ critical interpretation of the impact Dodd-Frank has had on the economy. Ms Yellen said bank lending had in fact expanded, rather than become more constrained, and that American banks were performing well compared to European counterparts.
Little detail on the Fed balance sheet
There was little detail offered on the closely watched issue of when the Fed will start to trim its balance sheet, which is particularly important for the mortgage market due to the large holdings at the central bank. “We want to wait to start this process until the process of normalisation is well under way,” said Ms Yellen.
Concurrently, president of the Federal Reserve Bank of Richmond Jeffrey Lacker said in a speech that he hoped the Fed would begin winding down its balance sheet this year.
“It is one of the most anticipated moves in the history of the Fed and I just don’t believe it will be that big of a deal,” said Walter Schmidt, manager of mortgage strategies at FTN Financial. “The selling already occurred after the election.”
Policy changes provide ‘considerable uncertainty’
Ms Yellen avoided commenting on the specifics of the new administration’s economic plans but continued to point out that higher growth and increased productivity should be a main objective, with greater fiscal expenditure — on Mr Trump’s list of plans — being one way to achieve this.
“While it is not my intention to opine on specific tax or spending proposals, I would point to the importance of improving the pace of longer-run economic growth and raising American living standards with policies aimed at improving productivity.”
She added that policy changes are among the sources of “considerable uncertainty” for the economic outlook.