Last Friday Janet Yellen was honoured with Havard University’s Radcliffe medal. Her remarks were scheduled for the afternoon, and given that Memorial Day week end had already unofficially started, I thought the chances of her commenting on current market conditions was low. Much to my surprise, Yellen was not deterred by the low liquidity holiday atmosphere.
Question - Greg Mankiw: A bunch of money managers in New York have delayed their trip to the Hamptons this afternoon so they could listen to your talk here today in case it moves markets. So here is your chance to move markets. Do you want to tell us anything about the path of monetary policy going forward? You are welcome to say ‘no.’ And if you say ‘no’ they can leave for the Hamptons.
Answer - Janet Yellen: Let me say a few sentences so I won’t delay them very long. The economy is continuing to improve. We saw weak growth in the first quarter of the year and relatively weak growth at the end of last year. Growth looks to be picking up from the various data that we monitor. And if that continues, and if the labour market continues to improve as I expect, and I do expect those things to occur, we will continue to monitor incoming data and we will assess risks to the outlook, but it’s appropriate (and I have said this in the past), for the Fed to gradually and cautiously increase our overnight interest rate over time and probably in the coming months, such a move would be appropriate.
Greg Mankiw: You can go to the Hamptons now.
I have read some analysis that claims Yellen did not signal a summer rate hike (cough cough Gundlach). All I can say to that is horseshit.
Going into this interview, there was still some uncertainty about whether the recent hawkish rhetoric emanating out of Federal Reserve Board members was truly representative of the entire committee. There was concern that maybe certain FOMC members went rogue and Yellen was not on the same page.
Yellen had the opportunity to duck this question and leave this uncertainty hanging in the marketplace. When Mankiw asked if she wanted to comment, he laid up the easy out. Instead of taking that option, Yellen plowed ahead and answered the question head on.
Her response firmly reassured the market the recent FOMC member comments were in line with the Chair’s beliefs.
Barring some major catastrophe, the Federal Reserve will hike rates this summer. Full stop. It’s that simple. There can be no clearer signal.
I am not sure if they will do it in June, or wait until July. Although the June meeting seems more logical as there is a scheduled press conference following the meeting, I almost think the Fed will choose July just to prove they can hike at any meeting. If I had to guess, the Fed will use the June meeting to cement expectations for a July hike.
But what will the markets do?
Forecasting a summer Fed rate hike is fairly easy (or at least I think it is - watch this call be way off base), but determining how the markets will handle a hawkish Fed is another story.
Will it be a repeat of the December 2015 hike? Will asset prices collapse in the wake of another 25 basis point hike? Are we going to have another bout of global economic turmoil? That certainly seems to be the popular thinking.
But think back to before the last hike. In the months leading up to December there were plenty of smart people like Leon Cooperman who were banging the drum on the theme that “early hikes are bullish for risk assets.” In fact the pundits warning otherwise were labeled Chicken Littles and were definitely in the minority.
Today it is almost the opposite situation. Few believe risk assets can handle higher US rates. In the event of a Fed hike, the surprise will not be a rerun of early 2016, but the opposite.
I am unsure in which camp I am pitching my tent. I have concerns the Federal Reserve is once again ignoring the precarious state of the global economy, but at the same time, the US dollar has corrected downward. The weakest holders of the US dollar carry trade have been unwound. That first hike is now behind us.
In terms of making a bet, I am leaning towards fading the market’s pessimistic forecast. I am still mulling it over, debating in my mind the market’s reaction, but make no mistake - the Federal Reserve will hike this summer. How markets handle it is much harder to determine.
Thanks for reading,