April 02

How Long Can Yellen Delay?

Federal Reserve Chair Janet Yellen has delivered a surprise dovish tilt in her commentary for two weeks in a row. At the March 16th FOMC meeting markets expected a continued move towards hiking interest rates, but Chair Yellen caught investors off guard, saying that only two rate hikes were likely in 2016 instead of four. This past week in a speech to the Economic Club of New York she said that the Fed must “proceed cautiously” in raising interest rates due to global market disruptions. The strange thing about these comments, is that in the two-week period between these two events four different regional Fed presidents actually said they preferred to hike rates at the April meeting. This chorus of hawkish commentary came from FOMC centrists Dennis Lockhart and James Bullard. It would seem that the Washington based Janet Yellen and her governor knows something the regional Fed presidents do not.

Some market participants have speculated that there was an informal central banker agreement at the latest G20 meeting. The Fed is to slow its pace of tightening while China promises not to further devalue the Yuan. It is impossible to know if this actually happened, but it does not seem too wild of guess given that the Fed suddenly no longer seems “data dependent”.

Looking at US data there are several encouraging signs. Job gains continue at around 200k per month while the labor force participation rate and average hourly earnings have been rising in the last four months. Core CPI is already 2.3%, while the Fed favored measure of inflation is at 1.7%. On the negative side, durable goods orders and the trade deficit have been a drag on growth with the Atlanta Fed’s GDPNow estimate for Q1 growth now down to 0.7%.

With numbers like these maybe Yellen is not too far off base with delaying action. The only cause for concern is that core inflation continues to march higher and can no longer be masked by year over year declines in energy prices. Rising rents are at the center of these developments, with Zillow reporting an average 3.3% increase in rents across the major US cities as of December 2015. Yellen may be able to fend off concerns about inflation as long as energy prices are falling, but if $26 proves to be the low in Oil, where will inflation be by mid 2017 if oil rebounds to $50?

This same conundrum would also land on the desks of Mario Draghi and Haruhiko Kuroda, both would likely be looking at inflation levels above 2%. It is too early to tell just how this will play out over the course of the next year, but if Yellen stays on this path of inaction the long end of the yield curve will eventually take notice.