Last week Janet (I’m not tellin’) Yellen gave her annual two-day Congressional testimony, making it clear during Tuesday’s discussion that she wants to move away from the concept that Fed guidance is a pledge and appears to still prefer more tortoise than hare policy moves, assuring the markets that while the Fed will remove the word “patient” from its forward guidance at some point, that change in wording alone will be insufficient for investors to assume a hike is imminent, leave the markets fretting, “Damn it Janet, Yellen isn’t tellin’.”
Ms. Yellen reminded Congress of the Fed’s dual mandate under Humphrey Hawkins and pointed out that while employment has improved, the participation rate is lower than expected and wage growth remains sluggish, leaving room for improvement.
So according to Yellen’s testimony, part of the Fed’s dual mandate has made progress, but not enough. The dual mandate also refers to long-run growth and stable prices. For growth, Q4 was just revised down to 2.2% for 2.6% annualized. The exceptionally cold weather over much of the U.S. coupled with the West Coast port closures/work-slowdown give little hope for a strong Q1. For example, Macy’s (M) recently reported that while at year-end the port slowdown had not yet had a material impact, “Since then… inventory levels have been negatively impacted particularly in apparel and accessories. Approximately 12% of our first quarter merchandise receipts are being delayed and this will have some impact on our sales, gross margin and expense in the first few months of the year.” The recent posts on economic data, ISMs, retail sales, NAHB, NFIB, durables and even consumer sentiment have all lined up below expectations with payroll the only bright spot, but only time will tell if that was more reflective of a drop in productivity.
As for the stable price goal, which has evolved into a quest for around 2% annual inflation, the US Producer Price index is down 0.27% as of January on a year-over-year basis. US Core Producer Price index is up 1.76% as of January on a year-over-year basis. Consumer prices are also well below the target 2%.
While Ms. Yellen did say the Fed is becoming less patient with low rates, we continue to see this Fed as more dovish and the data isn’t screaming inflation or a potentially overheating economy. Additionally, once the Fed does start rate hikes, we don’t think it will follow its usually pattern of consistent hikes with every meeting after the increase is initiated. Lastly, even though the likely vector for rates is eventually higher, investors should focus on the velocity of those increases. The initial quarter point increase would only happen if the economy could digest it, how soon and how fast subsequent increases come is what will really matter.
What does this mean for investors? First, this time really is different. The Fed has never waited this long, (five years) into a bull market to raise rates, nor has the world ever seen so much monetary stimulus coming from so many of the largest central banks. Therefore, when looking at historical norms, they need to be discounted to a degree given just how far off the reservation we are this time…perhaps even as far as Peter Pan’s Never, Never Land.
Investors also need to take into account just how many central banks around the world have been cutting rates. In the past few months, 16 central banks have cut rates: Albania, Australia, Canada, China, Denmark, Egypt, Europe (ECB), India, Pakistan, Peru, Romania, Singapore, Sweden, Switzerland, Turkey and Uzbekistan! All of the G7 and China are moving towards easing while the US alone is contemplating tightening. Today government bonds of various maturities in about ten countries are selling at negative yields! People are buying guaranteed losses. While Ms. Yellen didn’t mention the strength of the dollar on Tuesday as she did in January, the Fed is most certainly aware that raising rates in the US, with so many negative yields around the world, would increase demand for the dollar, pushing the currency up even further, which while lovely for importers, is brutal for US exporters.