Opinion

James Saft

Yellen delivers; tougher times ahead: James Saft

November 14, 2013

Nov 14 (Reuters) – On the standards by which these things
are judged, Janet Yellen’s confirmation hearings went well,
meaning markets rallied with little volatility.

Speaking before the U.S. Senate Banking Committee, the
Federal Reserve Chair nominee was dovish, but not so much as to
scare the horses.

“I consider it imperative that we do what we can to promote
a very strong recovery,” Yellen, currently the Fed’s vice chair,
told the panel.

Considering that the current recovery, though long in the
tooth, has only produced tepid jobs growth and below-target
inflation, a “very strong” recovery is going to require the
continued administration of stimulants.

For risk assets that was good but not unexpected news.

The S&P 500 rose a half a percent, 10-year U.S.
government bond yields fell by a couple of basis
points, or about 1 percent. All in all a creditable performance
in markets, especially considering Yellen has good reason to not
appear too dovish ahead of her confirmation votes.

While Yellen gave the impression that she and the FOMC would
certainly considering tapering before too long, she didn’t seem
to be in a great, tearing hurry about it.

“It’s important not to remove support especially when the
recovery is fragile and the tools available to monetary policy
should the economy falter are limited,” she said. “I believe it
could be costly to withdraw accommodation or to fail to provide
adequate accommodation.”

That statement is both true and perhaps a bit worrying.

Yellen is acknowledging that, as monetary policy is scraping
at the lower bound of the possible, her arsenal is not well
stocked.

At this point that arsenal would boil down to doing more of
what you’ve already done (with mixed results) or saying you will
do more, or do it for longer, or do it with less regard to the
risks.

If the Fed did taper and found the economy listing into a
recession, it could buy more bonds, it could buy other assets,
as the Bank of Japan is doing, or it could pledge to buy bonds
and hold rates lower for longer.

None of those is tried and tested, so the Fed has good
reason, it seems, to let things run for a bit.

SPRING CLEANING?

That probably means the Fed will not announce a taper in
December.

March is the next logical target date. Yellen will be in the
chair, and a press conference at which the reasons could be
explained is already scheduled.

One thing we did not learn much about at the hearing is the
possibility that the Fed introduces some new form of forward
guidance, essentially promising to keep rates lower for longer,
perhaps, as suggested in recent Fed research, by tying a rise to
a move down in the unemployment rate to as low as 5 percent.

Yellen did show some skepticism about the unemployment rate,
acknowledging that it perhaps flatters the employment situation
by undercounting discouraged workers.

The idea, though, of taking away bond buying slowly while
softening the blow with forward guidance has some attractions.

Bond buying is not only unproven, it is a large
redistribution of wealth upward, one which is having a
diminishing effect on the real economy.

And, as Steven Englander, foreign exchange strategist at
Citigroup, points out, there will be some real limitations on
how long the Fed can carry on buying $85 billion of bonds per
month.

If the Fed carries on buying $45 billion per month of
Treasuries, it will be buying a large portion of all of the
longer-dated debt the U.S. issues next year. With the Fed
already holding more than 40 percent of the longer-term (five
years maturity and over) Treasuries in existence, this leaves
them open to charges that they are affecting fiscal policy and
distorting the market.

So a taper, then, in March, with the Fed buying fewer
Treasuries while pledging to keep rates lower for longer could,
from several points of view, offer advantages. More of its
firepower would be ‘reaching’ Main St, via subsidizing mortgage
borrowing and concentrating on employment.

That’s not to say this will work well, or is wise.

Forward guidance is a policy which rests on the premise that
markets will believe what the Fed tells it, which is further
premised on the idea that the Fed knows what it ought to tell
markets.

Look at Britain, where the Bank of England has had to revise
its forward guidance, bringing closer the date of an expected
hike, after an unexpectedly (to the bank) quick recovery in
employment.

The problem is the markets never believed the BOE in the
first place, and were pricing in a rate rise sooner than it was
promising one.

The Fed arguably has both more power and credibility than
the BOE, but may find itself with both threatened if it relies
too much on them as an easy tool.
(At the time of publication, Reuters columnist James Saft did
not own any direct investments in securities mentioned in this
article. He may be an owner indirectly as an investor in a fund.
For previous columns by James Saft, click on )

(Editing by James Dalgleish)

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