The Importance of Yellen’s Comments

new business

Yellen’s talk after the North American markets closed was revealing even though she added little to market’s body of knowledge about the prospects for a June hike or the issues surrounding the balance sheet. That said she did nothing to dissuade the market from leaning toward a June hike, which through the Fed funds futures strip, the CME estimates near 63%.  

We had detected a shift in the Fed’s stance that we characterized as looking for data to confirm the recovery to now looking for opportunities to normalize conditions.  Yellen sees similarly.  She said the Fed has shifted from “a post-crisis exercise of healing” to now trying to sustain the economic progress.

Yellen, a labor economist in her own right before joining the Fed, acknowledges that the unemployment rate may be misleading.  She is concerned that the decline in the participation rate of prime-age workers may be concealing unemployment.  Some may be discouraged.  This hints at why despite the gradual rate hikes, Yellen still think monetary accommodation is necessary.

The Fed Chair expressed concern that the independence of the central bank is under threat.  The culprit is not the President but Congress.  She specifically cited the efforts to audit the Fed and to impose a decision-making rule, like the Taylor Rule.  Although many worried that Trump would encroach on the central bank’s independence, this seems increasingly unlikely.

The main reason is not ideological, but pragmatic.  There is no need to fight that battle.  Trump will influence the Fed the old-fashion way:  through the power of appointment.  He can nominate three of the seven board of governors this year and probably two more next year when Yellen’s and Fisher’s terms as Chair and Vice end.

It is possible that Trump re-appoints Yellen.  After all, Volcker, Greenspan, and Bernanke were appointed by the president from one party and reappointed by a president from the other party. However, it is clear that Trump does not see himself as limited by political tradition.  We would put low odds on Yellen being reappointed as Chair.

Lastly, within a discussion about global forces,  Yellen said that the surprise August 2015 devaluation of the Chinese yuan led to a tightening of financial conditions and this delayed a Fed hike.  Like others, we expected a hike in September 2015, which was later delivered in December.   The important point here and one that has policy implications is that many various measures, financial conditions are easier here at the start of Q2 than they were in December 2016 or just a few weeks ago.

The dollar traded poorly after European markets closed, amid heightened geopolitical tensions amid some reports about Chinese troop movement toward the North Korean border as the US brings an aircraft carrier into the region, and separately, the US is claiming that Russia had prior knowledge about the chemical attack in Syria.  The White House press secretary warned Syria of further action if it used chemical weapons or barrel bombs (barrels full of fuel and shrapnel).  Geopolitical risks tend to have a short-run impact on the markets.  We see Yellen’s comments as slightly hawkish in the current context, and barring a premature tightening of financial conditions, a June hike remains the most likely scenario, even after March’s poor jobs growth and the Atlanta Fed bringing its GDPNow tracker to 0.6% for Q1.