The trading sessions Tuesday in the main global markets, notably the US and Europe, were driven solely by one event — the new Federal Reserve chair Janet Yellen’s first testimony on Capitol Hill that took place 90 minutes after her prepared remarks were released at 8:30 a.m. Eastern Time. Markets reacted positively to her comments, with the Dow Jones Industrial Average reclaiming the 16,000 level.
The following are the key takeaways from her hearing:
- We should expect continuity and the quantitative easing (QE)/ taper would be carried forward in measured steps. “Only a notable change in outlook” would prompt the Federal Reserve to slow its pace of scaling back on its monthly purchases of bonds. This, of course, implies that is not on a “pre-set course”.
- The zero interest rate policy (ZIRP) regime is here to stay for a prolonged period. The market should not expect a rate hike even if the unemployment rate reaches 6.5 percent in the next couple of months. That level of unemployment is not a trigger, but rather a threshold to once again re-assess the economic outlook of the US economy. Like her predecessor Ben Bernanke, Yellen too is not satisfied with the labour market recovery and is “far from complete”.
One point which investors must watch out for in future Federal Open Market Committee (FOMC) statement releases is whether Yellen attributes the weakness in the job market to cyclical or structural problems. The participation rate has been steadily declining in the United States since 2002.
- On inflation front, Yellen referred to the Fed’s favourite indicator — the personal consumption expenditure (PCE) which is well below the two percent inflation objective of the Fed. Some of the softness reflects “factors that will likely prove to be transitory such as falling crude oil prices and declines in non-oil import prices”.
- Yellen did not seem concerned with the ongoing emerging market crisis. The recent collapse in the currencies of Brazil, Argentina, Turkey and South Africa are on her radar, but her tone suggested these events are unlikely to have negative spillover effects on the American recovery.
What’s interesting to note is that the bond market is not completely buying a US recovery thus far. The US 10-year bond yields briefly touched three percent in the latter half of last year. But the “Great Rotation” equity bulls have been talking about — that is the move of money out of bonds into stocks — has not completely played out yet.
The 10-year yield was around 2.724 percent in Tuesday’s session. Gold also extended its weekly gains and inched towards $1300/ounce due to the dovish statements and reiteration of the “no pre-set stance” on the QE taper.
The FOMC meets again March 18-19 and till then Yellen would have another job data report for February to better gauge the economic recovery. For the time being, she did the best she could on her debut. She kept it straight and simple and did not try to front-run the FOMC by making any new forward guidance comments. The US markets have recovered about two-thirds of their losses in recent weeks. Rightly so, the most trending twitter handle during her testimony was #doveempress.
(Vatsal Srivastava is a senior market analyst. The views expressed are personal. He can be contacted at email@example.com)