Let’s go over the past couple of week’s events in Federal Reserve land. On March 16th the FOMC left rates unchanged, but walked down forward tightening expectations. Goldman Sachs labeled it “one of the most dovish Fed meetings in the new millennium.” Risk assets shot up on the news. The US dollar sold off. Tinfoil hat wearing kooks (like me) even speculated there had been a deal at the Shanghai G20 meeting where the Federal Reserve agreed to ease off the brake for the sake of the global economy.
But just as quickly as the market began pricing in an easier Fed, the hawkish rhetoric started pouring out of the mouths of various FOMC committee members, and the market was left confused about the Fed’s true intentions. Did the market misunderstand one of the “most dovish meetings of this millennium?” For the next week there seemed to be a concerted effort by Federal Reserve officials to walk back the market’s interpretation of the recent FOMC meeting.
Even this morning in Singapore, San Francisco Federal Reserve President John Williams continued on with the hawkish tone. From Reuters:
“Others’ economic fates do not spell our own,” Williams said in a speech at the National University of Singapore on a trip to Asia.
“My view is essentially, let’s just stay on track. Let’s not get sidelined by the noise and distraction commentary can sometimes cause.”
“If we have inflation moving clearly towards 2 percent, if the U.S. economy continues to improve the way it did last year…I think the economy could easily handle two or more (rate) increases this year,” he told reporters.
These comments are consistent with a FOMC tuning for a traditional US recovery. I happen to believe applying this antiquated playbook caused the 1st quarter market (and more importantly economic) dislocation. There is a large contingent of FOMC members who believe rates should be normalized as soon as possible. They either do not understand, or do not care, about the massive role US dollar liquidity plays in the global economy. The Fed’s tightening has slowly starved the world of US dollars, choking off economic growth. The weakest and most leveraged players (energy companies and China) have collapsed from the removal of this oxygen.
Regardless of whether you agree with this analysis or not, there can be no denying FOMC members spent the last couple of weeks jawboning the market away from the dovish interpretation of the recent Fed decision.
Here comes Yellen
Yet in a stunning turn of events, Yellen spoke today at the Economic Club of NY and instead of confirming the FOMC members’ recent hawkish guidance, went completely the other way! Instead of just reaffirming the recent FOMC committee decision (which in itself would have been dovish), Yellen took the opportunity to guide even more dovishly. From her speech today:
Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy–specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities. While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.
Of course, economic conditions may evolve quite differently than anticipated in the baseline outlook, both in the near term and over the longer run. If so, as I emphasized earlier, the FOMC will adjust monetary policy as warranted. As our March decision and the latest revisions to the Summary of Economic Projections demonstrate, the Committee has not embarked on a preset course of tightening. Rather, our actions are data dependent, and the FOMC will adjust policy as needed to achieve its dual objectives
The really amazing part? Yellen’s willingness to acknowledge the Fed’s (and America’s) role within the global economy:
Specifically, we continue to expect further labor market improvement and a return of inflation to our 2 percent objective over the next two or three years, consistent with data over recent months. But this is not to say that global developments since the turn of the year have been inconsequential. In part, the baseline outlook for real activity and inflation is little changed because investors responded to those developments by marking down their expectations for the future path of the federal funds rate, thereby putting downward pressure on longer-term interest rates and cushioning the adverse effects on economic activity. In addition, global developments have increased the risks associated with that outlook. In light of these considerations, the Committee decided to leave the stance of policy unchanged in both January and March.
On the other hand, manufacturing and net exports have continued to be hard hit by slow global growth and the significant appreciation of the dollar since 2014. These same global developments have also weighed on business investment by limiting firms’ expected sales, thereby reducing their demand for capital goods; partly as a result, recent indicators of capital spending and business sentiment have been lackluster. In addition, business investment has been held down by the collapse in oil prices since late 2014, which is driving an ongoing steep decline in drilling activity. Low oil prices have also resulted in large-scale layoffs in the energy sector and adverse spillovers to output and employment in industries that support energy production.
This morning before Yellen’s remarks one of my favourite market strategists tweeted the following question:
I thought it was a great point. Last week I wrote about the possibility of a G20 Shanghai deal (Of course there was a deal). I must admit, the litany of hawkish FOMC members intent on driving back market easing expectations made me doubt my analysis.
However today’s uber dovish speech by Yellen has cemented my view the US has agreed to ease off on the brake for the sake of the global economy.
The scary part
My main concern is not whether Yellen wants to let the economy run hot, but whether she has control over the board to institute her plan. Can Yellen keep her lieutenants in line? Sure, everything is all well and good today, but tomorrow will we get more FOMC speakers trying to undo all of today’s market easing?
The FOMC board members do not seem at all on the same page. And that is scary. It makes investing in this environment much more difficult. One day a FOMC board member is trying to guide the market towards more tightening, the very next day, the Chairwoman is doing the exact opposite.
I wanted to wait until after Yellen’s speech to write today’s piece. And to some extent I am still amazed at how far to the other side of the boat she has shifted. I am still trying to put it all together and understand the ramifications of these jerky movements.
In the mean time, I still love gold and inflation protected securities. Yellen’s comments have only reinforced how much these Central Bankers are flying by the seat of their pants.
Thanks for reading,