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Janet Yellen Is About To Speak: Here’s What To Look For

Wednesday, July 12, 2017 7:02
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Fed Chair Yellen will be testifying to the House Financial Services committee at 1000EDT, followed by testimony tomorrow before the Senate Banking Committee (the testimony for both events is likely to be identical, as it has on previous occasions), however her prepared remarks will be released 90 minutes earlier, at 8:30am. Courtesy of RanSquawk, here are the main things to look for in her prepared testimony as well the subsequent Q&A.

  • Attention will be on the Q&A part of Yellen’s testimony. The Fed’s Monetary Policy Report, released Friday, provided little new information, reiterating gradual hikes, and gradual reduction of the balance sheet when it begins later this year. Indeed, the report largely echoed recent comments from Fed policymakers, as well as the FOMC’s June meeting.
  • Yellen is expected to toe the line, but her Q&A may be more revealing (although we wouldn’t hold our breath: the Fed chair has become increasingly talented at saying a lot without telling us anything new of consequence). Nevertheless, the balance sheet plans, and inflation are the two areas the market would like to hear about.
  • On inflation, the June meeting minutes indicated that most policymakers saw the recent softness in inflation as having little impact on the trend on inflation, though several were concerned that it might persist, indicating the divide on the FOMC. “The Minutes showed a Fed hiking on realised activity but forecasted inflation,” UBS says, “taken together, strong activity, tight labour markets, supportive financial conditions, decreased risks from abroad, and a belief in their inflation forecasts were enough reason for them to hike.” (NOTE: US June CPI data is released on Friday, which will be crucial in judging how transitory the recent softness is).
  • On balance sheet reduction, the key question is around the sequencing of rate hikes and balance sheet normalisation. There seems to be a consensus building that the Fed will begin to normalise its balance sheet in September, with the next hike coming in December, after the minutes revealed several believed normalisation would be appropriate in the next “couple of months”. Additionally, some insight into the logic behind the cap system would be welcomed, UBS says, arguing that the cap system put forward is anything but straightforward: “The asymmetric treatment of Treasury securities and MBS and the fact that the caps become largely irrelevant after a year make for a bit of a head-scratcher. Sadly, there was no further insight into how they came up with their plan.”
  • At the close of business on Friday, the market was pricing in a 69% chance that rates would be held between 100- 125bps in the July, September and November meetings, with the chance of a hike in December is slightly better than a coin flip.
  • It is also worth keeping an ear out for comments about the FOMC’s projection for the long-term Fed Funds Rate, currently 3%; the market clearly does not buy into that hike trajectory, pricing in just three more hikes between now and the end of 2019, compared with the FOMC forecast (made in June) that looks for another seven.

* * *

Finally, courtesy of Pedro da Costa, here are 5 questions that Yellen may be asked today:

1. Why are you raising interest rates if inflation is falling?

Fed officials are having increasing trouble justifying their outlook for continued interest rate increases this year and next in the face of inflation data that is slipping despite a historically low unemployment rate. Nor is Wall Street all that convinced, with many traders barely pricing in another rate hike this year.

“A further retreat from the Committee’s longer-run objective will prove increasingly difficult to disregard, particularly with both the annual rate in headline and core consumer inflation at near two-year lows,” says Lindsey Piegza, chief economist at Stifel Nicolaus.

Given the room afforded by low inflation, why not leave interest rates steady and wait to see solid wage increases before tightening monetary conditions further? 

Realistically, these are not questions Yellen will answer head on.

“Given the disagreement evident in the minutes of the last FOMC meeting, we don’t expect any definitive steer from Yellen on when the balance sheet run-down will begin or whether to expect a September rate hike,” writes Paul Ashworth of Capital Economics in a research note.

Still, her tone on the economy will offer insight into how high a bar the Fed currently has to divert from its rate hike path. It appears set pretty high.

2. What do you make of Republican efforts to dilute post-crisis financial rules?

As much as Yellen avoids talking politics, financial regulation is certainly part of her mandate, and she’s already had much to say about Trump and the Republican Congress’ efforts to reverse many of the post-crisis reforms intended to prevent another meltdown. 

“We lived through a devastating financial crisis. Most members of Congress and the public came away from that experience feeling that it was important to take a set of steps that would result in a safer and stronger financial system,” she said during her last testimony in February. “I feel that we have done that.”

Yellen will likely get asked about the issue again, given many Republicans and Wall Street CEOs blame bank regulation for weak economic growth. Trump’s board nominee for financial regulation, Randall Quarles, is a creature of Wall Street, meaning Yellen must redouble her effort to push back against what is effectively an undoing of the work she and her colleagues have spent seven years undertaking.

3. What are you doing to boost financial stability and monitor market bubbles?

Fed officials have often cautioned against raising interest rates in order to tame asset market bubbles. But with inflation nowhere to be seen in the current economic horizon, it’s hard not to get the feeling that the Fed’s resolve to keep raising borrowing costs after a prolonged period of zero interest rates is in part due to its fears of an ever-rallying stock market.

Yet policymakers including Yellen have described such an approach — slowing down the entire economy just to soften a single market — as counterproductive. Instead, they have talked about using “other tools” to monitor and if needed restrain particular corners of finance. These policies are sometimes referred to as “macroprudential,” and could include things like loan-to-value restraints or curbs on leverage. But officials have never been specific about what they could do, or how? It’s time for Yellen to provide more clarity on this front. 

Ethan Harris, economist at Bank of America-Merrill Lynch sheds some light on this internal debate in a note to clients. 

“This year the Fed appears to have shifted to a ‘hawkish bias.’ This was evident when the Fed hiked rates and signaled balance shrinkage at its June meeting despite weak growth and inflation data. Why the change of feathers?”

Among other factors, he says, “the Fed is worried a bit about financial stability and overheating markets. However, we put a relatively low weight on this argument. Chair Yellen and her allies have repeatedly underscored the idea that macro prudential policy is the first line of defense against asset bubbles and monetary policy is a distant ‘Plan B.’”

 4. Why are you tweaking the Fed’s balance sheet now and where do you see it headed?

The Fed has complicated the outlook for official interest rates by announcing potentially imminent changes to its balance sheet policy, which directly affects the amount of outstanding stimulus in the economy — at least according to standard monetary theory.

But it has left a number of unanswered questions about when and and to what extent it will reduce bond buys, by gradually easing up on reinvesting proceeds of maturing bonds in its $4.5 trillion balance sheet back into the market.

Fed Governor Lael Brainard said this week she was pretty much ready to announce a start to balance sheet reduction, although she sounded more skeptical about continued interest rate hikes. “I believe it would be appropriate soon to commence the gradual and predictable process of allowing the balance sheet to run off,” Brainard said in a speech

Lawmakers should ask Yellen for further clarification as to why the Fed has decided to further muddy the interest rate outlook at a time when the political environment is itself a source of extreme uncertainty. 

5. Any comments about your long-time colleague, ex-Richmond Fed President Jeffrey Lacker?

Lacker resigned in April after admitting to confirming confidential information to Medley Global Advisors, a consulting firm that then sold those details directly to clients in a private report. Yellen overlapped with Lacker at the Fed for over a decade, and yet she has never made a public statement about his resignation. Before becoming Fed Chair, she was vice chair and before that held a role parallel to Lacker’s, as president of the San Francisco Fed.

She and the Fed have also not addressed the main question arising from Lacker’s resignation letter. If he was merely confirming details Medley already had, who was the original leaker? This is especially relevant because the House Financial Services Committee says it still has an open investigation into the matter. At a time of heightened scrutiny over ethical scandals, the Fed would only help itself by boosting transparency on this issue, if only to put it to rest


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