Fed Yellen Speech: Quick Take
The 'Yellen Call' Postponed; Tomorrow's Data An Interesting Test The ‘Bernanke put’ was the idea that when growth risk is skewed to the downside meaningful declines in market sentiment will likely be met with aggressive monetary stimulus (cushioning market declines).
The ‘Yellen call’, by contrast, is our notion that when labor markets are near full employment and core PCE inflation is rising meaningful improvements in market sentiment will likely be met with aggressive withdrawal of policy accommodation.
As it happens, market sentiment fluctuated sharply in Q1 alongside rising concerns about global growth which, combined with this week’s unmistakably dovish speech by Fed Chair Yellen suggests to us that the ‘Yellen call’ is postponed to H2.
While she acknowledged that core inflation had risen “somewhat more” than she expected in December, this was heavily qualified with her view that it is “too early to tell if this recent faster pace will prove durable”, and that, given the risks to the outlook, it would be appropriate to “proceed cautiously in adjusting policy”.
This adjustment says to us that the risk to risky assets stemming from the ‘Yellen call’, in other words, is temporarily postponed. In particular, we do not expect the ‘Yellen call’ to be reactivated until the second half of the year, by which time our economics team expects that US growth will have pushed unemployment rates lower and core inflation rates higher. This will likely justify a resumption of rate hikes in the second half of the year, and likely at a pace faster than is currently envisioned in the ‘dots’ offered by FOMC members. But, between now and June, risky asset markets have been given a reprieve. Put differently, with monetary concerns temporarily sidelined, good news should be good news for risky assets.
We still expect three more hikes in H2 of this year but between now and June, at least, risky asset markets have been given a reprieve.
Tomorrow’s economic calendar will provide an interesting test. We expect US data to be moderately stronger than expected. Consensus forecasts expect nonfarm payrolls to rise 210k vs. 220k for GS (from 242k last month) and ISM manufacturing to rise to 50.5 vs 51.0 for GS (from 49.5 last month).
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It’s been only weeks since the Fed’s dovish decision in March, so it’s no surprise today’s speech by Yellen didn’t diverge much from the wait and see stance adopted by the FOMC. But the topic of the speech, why rate hikes when they come will likely only be gradual, made it inherently dovish in tone. Yellen cites existing headwinds as reasons wh the current real neutral rate is low, albeit higher than current rates which are designed to close the remaining output gap. But looking ahead, rate hikes will be tempered by spillovers from still tame global growth and its downside pressure on US growth/inflation, and by the low starting point for the fed funds rate, which leaves less room to ease if the economy surprises to the downside.
On the more hawkish side, Yellen isn’t convinced that inflation expectations have fallen as much as market based measures (e.g. those derived from TIPS) suggest, expects that the base case involves a lessening of global headwinds ahead, and does at least mention that there could be upside surprises to either growth or inflation.On balance, Yellen has cloaked herself in dovish wings, which at least for April, keeps the Fed on hold, and is consistent with our view that a hike in June could be followed by another long pause. Market reaction will be bullish for short dated bonds, bearish for the USD.