The maiden monetary policy report by Chairwoman Janet Yellen is neither hawkish nor dovish. This was somewhat expected despite hyped-up market expectations. Along with former Chairman Bernanke, Chairwoman was one of the prime architects of the current policy so it should not have been surprising that her prepared remarks were quiet unexciting given that nothing remarkable – one way or another – has happened to the US economy recently.
Chairwoman Yellen was fully behind Fed’s deployment of the non-traditional tools during this ZIRP era and was instrumental in the tapering strategy too. Tapering has been progressing as announced since mid-2013 and economy is also moving along without many hiccups since then, notwithstanding couple of non-farm payroll misses. So she is standing pat.
We reviewed her report and here are some of our observations.
Fed may not be too thrilled with current economic situation but it is also not too alarmed. Given the lack of support from fiscal policy it is satisfied with the results of its strategy. Chairwoman thinks that Fed’s strategies are successful and we concur. She specifically noted favorable aspects of the strategy:
- Real GDP is estimated to have risen at an average of 3.5% in the third and fourth quarters as compared to 1.75% from the first half
- Economy added 1.25 million jobs since July ’13 and 3.25 since August ’12, the month before Fed began new round of asset purchases. A total of 4.5 million jobs in 17 months is not bad considering ongoing obstacles from the fiscal policies
- Household and business spending and investment stepped up in the second half of last year
- Inflation has remained low – both headline and core PCE price indexes rose only about 1% in 2013
She also noted things that still concern the Fed:
- Recovery in housing sector slowed in the later part of the year due to increase in mortgage rates
- Recovery is still far from complete
- Unemployment still above the levels that FOMC’s view of maximum sustained employment
- Number of people working part-time but would prefer full-time job remain worrisome
The Fed thinks that the economic activity and employment will expand at a moderate pace in 2014 and 2015 and the inflation will move back towards 2% over coming years. The Fed expects the current low target range for fed funds rate to be appropriate at least as long as:
- The unemployment rate remains above 6.5%
- The inflation is projected to be no more than a half percentage point above 2% longer-run goal
- Longer-term inflation expectations remain well anchored
So the question is what is Fed going to do going forward. The good and bad attributes of the economy means that the Fed is going to consider, as Chairwoman Yellen said, more than the unemployment rate when evaluating the condition of US labor market. It is not very much concerned with the recent volatility in global financial markets as they do not pose a substantial risk to US economic outlook. In fact it is other way around. Fed’s actions are fueling the volatility in the global market and it is not concerned.
Chairwoman Yellen’s first speech to the Congress in the new role gives us an opportunity to assess her approach. Her statement, “purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases”, means that she is not ideologically driven and will reverse course if needed. This is why we were not surprised that her testimony was not dovish as we never believed her to be is a perma-dove.
She mentioned thresholds for maintaining the current funds rate but then added that crossing one of them will not automatically prompt an increase in rate. This was not surprising to us as we think that she would like to keep Fed’s options open. Her decisions are not strictly rule based but also driven by her immediate assessment of broader economic outlook at the time the decision needs to be made.
We think that the chances of asset purchase program to wind down by the end of year are realistic. We expected this when the Fed embarked on the tapering in December ‘13 and stuck with it January ’14. There are seven more FOMC meetings scheduled for 2014 and most likely all of them will continue with the pace of reduction.
We also believe, as she said, Fed’s highly accommodative monetary policy will remain appropriate for a considerable time after the end of asset purchases. This means even selling of assets that the Fed has purchased during QE3 will not start for a foreseeable period and certainly not automatic when the program is wound down.
The bottom line is that wind blowing from Fed’s direction is going to be favorable to some asset classes and un-favorable to others. We will write soon about them in other posts.