Let’s sit back and take stock on some of the major points that Fed Chairperson Yellen had made in two straight days of testimonies, shall we? Specifically, let’s take a look at Yellen’s views on the U.S. economy, the possibility of a Brexit, monetary policy, and the U.S. stock market.
Views on the U.S. economy
With regard to GDP, Fed Head Yellen said in her prepared statement that growth has been disappointing since subdued growth abroad and the relatively strong Greenback are weighing down on U.S. exports while the “steep drop in oil prices since mid-2014” has bludgeoned the energy sector, not to mention the “surprisingly weak” levels of business investment.
She then shifted her focus on the expected rebound in Q2 2016, which was already touched upon during the June FOMC statement and presser. She expounded on it, however, attributing the rebound to consumer spending, which has “picked up smartly in recent months, supported by solid growth in real disposable income and the ongoing effects of the increases in household wealth.” And when she was asked during the Q&A portion on the chances of a recession this year, she said that the “U.S. economy is doing well,” so the chances for a recession this year are “quite low.”
Going back to that bit about the “surprisingly weak” levels of investment, there was an amusing exchange between Representative Andy Barr and Fed Head Yellen during her testimony before the House Financial Services Committee.
Barr said that “maybe the reason why the Fed is surprised and continued to miss on forecasts” is because of “the Federal Reserve’s consistent record of forecasting error from a standpoint of predicting stronger growth than is actually occurring.” Barr is basically saying the Fed is always caught off guard because the Fed tends to be over optimistic on its forecasts. Before defending the Fed’s forecasts, Yellen first said that: “Well, growth has been disappointing. I’m not sure of the reason.” Hmm. Very Interesting. Is that just a figure of speech or an actual admission? I’ll leave that up to you to decide.
Moving on to the labor market, she expressed disappointment over the May NFP report, but said that “it is important not to overreact to one or two reports,” which is what she also said during the June FOMC presser, as well as her June 6 speech. She added, however, that “there are some tentative signs that wage growth may finally be picking up,” and she stressed that the “recent slowing in employment growth is transitory.”
As for inflation, she didn’t really add anything new to what was already said during the June FOMC statement and presser. She merely reiterated that the she and other Fed officials expect inflation to pick up as the “transitory influences” in the past declines of energy and import prices (food items in particular) begin to fade away.
Overall, Fed Head Yellen sounded rather optimistic on the U.S. economy, but she also tempered her tone a bit by saying that there is “considerable uncertainty about the economic outlook.”
The first uncertainty she pointed out was that “domestic demand might falter,” citing the disappointing levels of business investment, the recent deterioration in the labor market, and the possibility that “the slow productivity growth seen in recent years will continue into the future.”
The other source of uncertainty that she identified were the vulnerabilities in the global economy, specifically the slowdown in China as China shifts away from an export-driven economy, as well as the threat of a Brexit from the United Kingdom.
Depending on when you’re reading this write-up, the following part may or may not be all that significant. Anyhow, Yellen said in her prepared statement that a “U.K. vote to exit the European Union could have significant economic repercussions.”
She then added during the Q&A portion that: “Brexit is a risk that we are monitoring. We will be watching closely to see what the vote is and what possible repercussions it might have.” But when she was asked if she has scheduled a special meeting just in case Britons vote in favor of a Brexit, she replied: “No, I have not.” Looks like the U.S. Fed doesn’t have an immediate contingency plan in case of a Brexit, unlike the ever-ready ECB under Emperor Draghi.
On monetary policy
Fed Chair Yellen said that a more cautious and slower path to hiking rates is appropriate for two reasons.
The first reason is because of the “continuing below-target inflation and the mixed readings on the labor market and economic growth seen this year,” so economic indicators (so far) basically don’t support rapid rate hikes.
And I guess that economic indicators are not looking too good from the Fed’s perspective since the Fed already reduced the number of projected rate hikes in 2016 from 3-4 back in December to just 1-2 during the March FOMC statement and then proceeded to downgrade rate hike projections for 2017 and 2018 during the June FOMC statement.
Getting back on topic, the second reason for a more cautious path to tightening is that the Fed doesn’t have enough room to cut further if the economy doesn’t grow as forecasted or low inflation persists.
Adding negative rates to its toolbox was discussed during the Q&A portion, and Yellen said that: “We (the Fed) do have legal basis to pursue negative rates,” but she added that it is “not something that’s on our list,” and that “it is not something we are considering.”
Yep, negative rates are not in the Fed’s toolbox yet, but now we know that the Fed can legally use negative rates if it has to.
On the stock market
As I noted earlier, Representative Andy Barr was a bit insulting to Yellen and the Fed as a whole. He wasn’t the only inquisitor, though. Representative Edward Royce also grilled Yellen and the Fed, accusing the Fed of creating a “third pillar of monetary policy, that of a stable and rising stock market,” referring to the current bull market, which is one of the longest bull markets in U.S. history.
Royce then cited formed Fed Head Ben Shalom Bernanke’s statement that “the goal of QE was to increase asset prices like the stock market to create a wealth effect,” adding that hiking rates and reducing the Fed’s $4.5 trillion QE balance sheet could result in “a declining stock market and a slight deflation of the asset bubble that QE created.”
Royce then pointed to the Fed’s history of using stock market volatility “as one of the reasons to stay the course and hold rates at zero” before allowing Yellen to finally defend herself and the Fed. And Yellen simply replied that: “It is not a third pillar of monetary policy. We do not target the level of stock prices. That is not an appropriate thing for us to do.” So there you have it! As to whether you take Yellen on her word or not, that’s up to you.