Yellen spooks markets in her Fed debut

Posted on 03-25-2014 01:03
Summary: Janet Yellen rattled investors in her debut as the U.S.’s top central banker, as Wall Street focused on an apparent tilt toward raising interest rates sooner than expected.

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Janet Yellen rattled investors in her debut as the U.S.’s top central banker, as Wall Street focused on an apparent tilt toward raising interest rates sooner than expected.

Ms. Yellen told a press conference in Washington on Wednesday that “almost nothing has changed” with Federal Reserve policy since leaders took a hard look at the state of the economy at the end of last year, when Ben Bernanke was winding down his tenure as chairman.

But investors took notice of a March survey of Fed policy makers that showed a modestly higher estimate of interest rates for the end of 2015 and 2016.

The prospect of higher interest rates and stubbornly lacklustre economic growth was enough to prompt traders to sell equities, prompting a 0.6-per-cent drop in the Standard & Poor’s 500 Index. The yield on five-year Treasury notes spiked as much as 20 basis points. The U.S. dollar also rallied, and the price of gold fell by almost 2 per cent.

The volatility was the latest reminder of the difficulty Ms. Yellen and other central bankers face in attempting to transition from a period of extraordinary monetary stimulus to policies that resemble their pre-crisis settings.

“The Fed wasn’t particularly successful in better guiding the market as to its intentions,” said Adrian Miller, director of fixed-income strategy at GMP Securities in New York.

Ms. Yellen, who replaced Mr. Bernanke in February, had just concluded her first gathering as chairwoman of the Federal Open Market Committee. Over two days, the Fed’s top officials held discussions that led to a shaving of the Fed’s forecast for economic growth, the interest rate tilt, and the adoption of a more nuanced explanation of what will guide the central bank’s ultimate decision to raise borrowing costs.

As expected, the Fed reduced its monthly bond-purchase program by another $10-billion (U.S.), resetting its quantitative-easing policy at $55-billion.

But the big change from January was the decision to sever the link between a shift in monetary policy and an unemployment rate of 6.5 per cent.

Since December, 2012, the 6.5-per-cent target had been the Fed’s way of signalling that it intended to leave its benchmark interest rate near zero for a very long time. When the Fed adopted the unusually explicit description of its intentions, the jobless rate was uncomfortably close to 9 per cent.

Now, the unemployment rate is 6.7 per cent, but policy makers still think the economy is too weak to stand higher borrowing costs.

So central bankers determined that they should alter their communications plan to make sure the public understands that the Fed still is a long way from raising interest rates. They now say they will “take into account a wide range of information” in determining when to lift interest rates, including various measures of labour-market conditions and inflation expectations.

“With the unemployment rate nearing 6.5 per cent, the committee has updated its forward guidance,” the Fed said in its revised policy statement. “The change in the committee’s guidance does not indicate any change in the committee’s policy intentions as set forth in recent statements.”

The assertion that nothing had changed was undermined by the Fed’s quarterly round up of policy makers’ estimates of the benchmark lending rate at the end of the following few years. The March survey showed a median estimate of 1 per cent at the end of 2015, a quarter-point increase from January, and an estimate of 2.25 per cent at the end of 2016, a half-point shift in the previous outlook.

Those are minor adjustments to projections that extend well into the future. But investors make their bets based on what they think assets will be worth months from now, not today. At the same time, the Fed acknowledged in its assessment of the economy that “activity had slowed during the winter months,” and that the slowdown was only partially the result of exceptionally frigid and snowy weather.

The market reaction to the Fed’s new policy statement will displease Ms. Yellen, one of the main architects of the Fed’s communication strategy, as central bankers prefer to avoid being the sources of market volatility.

“To my mind, there is only very limited upward drift” in the Fed’s outlook for interest rates, Ms. Yellen told reporters. “If you compare today’s assessment with December’s, it is virtually identical. Almost nothing has changed.”

KEVIN CARMICHAEL

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