Yellen’s testimony – No change to the Fed’s view

If Fed chair Yellen’s speech today was an opportunity to communicate a more dovish outlook for US interest rates it has been passed up. Yellen highlighted the decline in the US unemployment rate to 4.9%, in-line with the Fed’s own longer-run estimate of a sustainable level and only talked of the uncertainty in regard to recent external factors and financial market movements – and notably to both the upside and downside. This gives little ammunition for bulls expecting a quick and wholesale reappraisal of the trajectory of US interest rates.

Moreover, while recognising that financial conditions have tightened in the US (and we believe significantly so over the last 6m) in Yellen’s view it is only if this proves persistent will any impact be felt on the outlook for the labour market and US economy. This assertion also deviates somewhat from the market script that the Fed will shortly change course on monetary policy.

Furthermore, by stating that the employment gains and faster wage growth, Exhibit 1, should support the US economy and highly accommodative monetary policies abroad will support a pick up in global economic growth the emphasis is clearly on a US monetary policy focused on a US economy; in Yellen’s view, foreign central banks are assumed to be capable of stimulating growth abroad. However, given the widely-acknowledged impact of tighter US dollar funding conditions on emerging markets this would seem to be an assumption which could in future be challenged. The bind that emerging nations are in is that they cannot readily ease domestic monetary policy due to the risk of further capital flight as investors fear FX devaluations.

Exhibit 1: US real wage growth recovers Source: Thomson Reuters

Though note is taken of the decline in market-based measures of inflation these are largely discounted by “changes in risk and liquidity premiums”. Inflation survey data is described as at the low end of long run averages but reasonably stable.

To stabilise equity markets at close to current levels requires in our view an easing of the upward pressure on the dollar and by implication a convergence of Fed policy closer to market expectations of no US interest rate increases during 2016.

Yellen may have been keen to avoid the impression of allowing the markets to dictate policy, or of setting policy expectations unilaterally ahead of the FOMC, in contrast to the apparent habit of the ECB President. But there was a window of opportunity to acknowledge declining US and global growth expectations for 2016 which was not taken up; it may in the circumstances be presumptuous assume the Fed will grant investors their wish of a complete U-turn in US monetary policy as soon as the March 15 FOMC meeting.