Blogging regularly is an interesting chore. Sometimes the most important topic to talk about is obvious, and other times it’s hard to find. Sometimes the title is self-evident, and other times it doesn’t present itself until long after the fifth draft. It’s an odd process to the say the least.
This week’s title came to me like an epiphany as I watched Janet Yellen take questions from reporters for her first time since taking the top job at the Federal Reserve. Yellen’s message was mostly the same as Ben Bernanke’s, no doubt, but her presentation was undeniably different. And it has me interested.
Many people with concrete values and perspectives have assumed high political office only to change their believe structure soon after appointment, and in dramatic fashion. Small government advocate Thomas Jefferson and his authoritarian approach to the Louisiana Purchase is a case in point. Today’s question is simple: Will Janet Yellen be as “accommodative” to the Obama agenda as Ben Bernanke was, or will she force the hands of fiscal governors by taking a new strong dollar position?
“The market” seemed to be confused about her message last Wednesday, as stocks sold off while she took questions from the press. But why? Yellen continued former Fed chairman Bernanke’s QE tapering plan by decreasing the amount of new money by $10 billion per month. Banks will now get $55 billion of fresh new cash every month – an amount that will provide the U.S. Treasury plenty of wiggle room to fund government debt and deficit for the current fiscal year.
Without congressional action, the Fed is best positioned to reel-in runaway spending programs advocated by President Obama. All by herself, Yellen can make it harder for Congress to authorize irresponsible spending without impunity. Higher interest rates will do that.
Interest rates have no choice but to rise without QE support. This is a simple matter of supply and demand. At current levels QE satisfies 100% of annual government deficits (estimated this year to be approximately $600 billion, or $50 billion per month.) When the Federal Reserve stops printing money to buy new debt the free-market will have to fill that gap; and sooner or later lenders will demand higher rates of interest to do it. That force, the pricing power of the free-market system, will prove the Reverse Repo an inept tool for keeping rates low.
Yellen is smart enough to know this. And so is the Wall Street establishment.
That’s why the stock market gets so antsy around every Fed meeting. Out of one side of their mouth the Fed continues the QE taper (an essential tightening of money) and out of the other side promises to remain “accommodative” (i.o.w. to maintain cheap and easy money policy) into the foreseeable future. The two positions are contradictory, and as such, institutional investors don’t know what to think – hence Wall Street’s itchy trigger finger.
While a main objective of QE was to keep yields low, another major goal was to strengthen large U.S. banks. The Fed reported this week that 29 of the 30 largest U.S. banks passed their most recent stress tests, a measuring stick implemented in the wake of the ’08 crash. This provides the Fed further support to continue tapering QE. And like Bernanke, Yellen put forth the conventional caveat to QE tapering and future interest rate hikes – they’re both conditional based on economic performance. This seemed to add more uncertainty to the trading public.
Some institutional investors took her comments as an indication that the Fed would raise interest rates sooner and more aggressively than Bernanke had suggested just a few months ago. It was this interpretation that sent stocks initially lower.
But stocks regained their upside footing by week’s end under the prevailing thought that Yellen’s remarks were most likely a “rookie gaffe.” I’m not so sure about that. Yellen has been around the Fed game for a very long time. Calling her wet behind the ears is a bit too trite for me to swallow.
This is an election year that should feature a clash between fiscal prudence and unlimited government spending. By setting a tighter monetary stage after the election takes place and a new Congress is installed, Yellen is sending a very important message to the boys and girls in Washington DC: take fiscal matters more seriously because deficit financing will not always be as easy as it has been.
While it is hard to know how Janet Yellen will govern monetary policy over the long term, one thing is for sure: she didn’t sound like the dove everybody had anticipated. It was quite evident in this first press conference that she knows how difficult it’s going to be to gracefully unwind the excess liquidity QE has produced – and that she’ll need higher interest rates to do it.
That’s why bond traders are so skittish. They’re looking to protect their flank by making portfolio adjustments the second interest rates pivot to the upside. They were expecting Yellen to favor easier money (lower yields) for a longer duration than Bernanke did. But that didn’t come across this week – and it left traders wondering, Who is Yellen now?
The answer to that question will evolve over time – and it will be interesting to watch.
Stay tuned…
