Monday, February 8, 2016

Yellen to testify twice this week- be prepared

Yellen to testify twice
It went so nice she did it twice? Not likely…

The Fed Chairman’s twice yearly testimonies one set of two testimonies before the Senate Banking Committee and the other before the House Financial Services Committee, is a legacy of the old Humphry-Hawkins legislation.   The Fed reports twice-yearly to each of these committees usually in testimonies that are back-to-back or nearly so, one early in the year, the other after mid-year. This week they will be on Wednesday and Thursday

This year there may be fireworks. The Senators are the better-prepared while House of Representatives has a lot of members who are only tangentially acquainted with finance and really know far less about the Fed than they should for being members of this ‘oversight’ committee. For many of the members this is a chance to score political points and rake the Fed over the coals for ideological issues.  

This year ideology should loom large as the Fed is being blamed for the stock market sell-off as a result of its attempt to get back to normalcy. The argument is that the excessively long period of excessively low rates boosted stocks and now that it is ending, the temporary boost to stocks is going away making the Fed responsible for the sell-off (Martin Feldstein holds this belief). To another set of Fed detractors, the problem is simply Fed policy and raising rates at a time that is inappropriate. To yet another group it is the Fed hiking rates at a time and under conditions that are not the conditions that the Fed said would have to exist in order to raise rates- to this group the Fed rate hikes have shattered Fed credibility as inflation is too low and is nowhere near 2% and far from being credibly on a path to 2%.

There are other related issues here that are intertwined and complicated. There is the issue of Fed communication and Fed credibility. For example the Fed has a policy statement and it also has member speeches. The public is confounded about which of these represents policy. Last year a number of members (most of them, actually) had declared that they thought interest rates would finally go up by year end. Despite the Fed not seeming to have the conditions for a rate hike it laid out in its post meeting policy statements all year long, it did hike rates in December.

Some in markets had cast the event of a hike or no hike as a Fed credibility issue. Many argued that since members were ‘expecting a hike’ if a hike were not forthcoming, Fed credibility would suffer. Yet in a speech in Lima, Peru, before an IMF meeting late last year, Fed Vice Chair, Stanley Fischer, had noted that Fed speeches about expected policy actions represent member expectations - not policy. Policy is made in the Fed policy statement released after each meeting. Apparently it is also made in the Yellen Press Conference as it was there that Janet Yellen last year suggested that a further tightening of the labor market could be taken as evidence than inflation would be rising to the Fed’s goal of 2% even if inflation itself were lagging. Fed Governor Lael Brainard had pushed back against that notion. The making of Fed policy and its communication to the public has become quite complicated. It seems it can no longer be singularly expressed as the Fed’s post meeting policy statement. And that IS confusing.  And it’s fair to say that even among Fed experts you are likely to find different assessments of what the Fed is telling us that constitutes policy.

These various descriptions about Fed policy illustrate how confusing Fed communication has become. Let me add to the mix another significant complication, the Fed’s so-called SEP. Four times a year the Fed polls FOMC members and memorializes their averages and central tendencies as well as providing a time series of the member’s independent outlooks for selected economic variables. Even Fed officials themselves seem to have different ways to refer to this exercise. It is not a ‘Fed’ forecast. It is the personal view of Fed members based on what each thinks the right monetary policy should be given the conditions each member sees. As such these scenarios provide us with some information but also add to the confusion of where the Fed stands and how much these scenarios influence Fed policy among other existing Fed communications.

Wednesday Thursday February 10 and 11, 2016
Against this background Yellen will testify to the House and Senate Committees. In addition she will undoubtedly be grilled over just what policy is and how it views the ongoing state of affairs with the economy and markets. The NASDAQ is hitting its lowest reading since June 2014 ahead of this testimony. Everybody will be tuning in on this one. It’s a presidential election year putting the Fed even more on the hot-seat.

There is a lot here for Yellen to defend or simply explain. These have not been the Fed’s brightest days. There is a lot of dogma in Fed policy, too. By dogma I mean that the Fed is making policy now for the conditions it believes will occur in the future based on its view of the world and its view of ongoing economic progress.  Policy is not reacting to or doing much for the economy’s current needs. Martin Feldstein thinks this is just the right approach. Is it? That question is intrinsically unanswerable at the moment because we will need to see the future and how it pans out to know if the Fed really is doing the right thing today. For today Fed policy is uncomfortable and has been made with too many warts to boot.

We could see Janet Yellen this week looking more uncomfortable than she ever has looked. The stakes remain high.


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