A Nation and World Turns its Ear to Janet Yellen

February 9, 2016

Janet Yellen will be testifying Wednesday on the U.S. economy and monetary policy before the House Financial Services Committee and reprising her message Thursday to the Senate Banking Committee.  Formerly known as the semi-annual Humphrey-Hawkins Hearings, Congress can be an unfriendly audience for Fed Chair-persons, especially in election years like this one.  Yellen’s task will be also complicated by financial market turmoil that seemed to accelerate after the initial federal funds rate increase eight weeks ago.  In that span, West Texas Intermediate oil has tumbled 22.7%, the S&P 500 has dropped 10.3%, the ten-year Treasury yield has pivoted 58 basis points southward from 29 basis points above 2.00% to 29 basis points below, and the dollar has lost 10.3% against gold, 5.6% against the yen and 3.0% relative to the euro. Opponents of the central bank’s authority hope this will be the end of the Fed’s authority as we know it, and they in theory have the the power to make it so, since the Federal Reserve institution and defined role in U.S. economic policymaking is a creation of the legislative branch of the U.S. government.  Iowa Caucus winner Senator Ted Cruz for one wants to reinstate the Gold Standard, which would greatly reduce discretionary monetary policy.

When last heard at her post-rate hike press conference on December 16, Yellen of a need for policy to be preemptive because of the lagged nature of policy’s impact.  She promised only gradual, non-mechanistic adjustments in interest rates that will be decided meeting to meeting after a careful evaluation fo actual and expected progress toward reaching the goal of 2% inflation.  The first rate hike was made in spite of a drop in some market-based measures of expected inflation but also in the face of lessening underutilization of labor.  Growth risks were considered balanced, and monetary policy would remain accommodative for quite some time longer as policymakers intended to proceed with caution.  The vote to start rate normalization had drawn no dissents against the move or in favor of a sharper rate advance.

Yellen’s last semi-annual Humphrey-Hawkins presentation in mid-July 2015 had foreshadowed the action taken in December.  She predicted positive U.S. economic growth in the second half of the year, a drop in unemployment and implied that an initial rate hike would be undertaken before end-2015 if the economy evolved along expected lines.  The extent of slowdown in U.S. growth from 3.9% in the second quarter to 2.0% in 3Q and 0.7% last quarter was not foreseen, however.  Oil prices, which from a peak in June 2014 had been roughly halved, has plunged by almost 50% yet again since that testimony, creating another surprise that increasingly casts doubt on the wisdom of the Fed’s timing, first delaying an initial rate hike when many pundits thought such was warranted and then acting at just the point when a darkening global environment began to suggest that the window for safely beginning rate normalization was shutting down. 

In hostile surroundings, Yellen’s priority at these hearings is to convey confidence to dispel fears that the U.S. and world economies needn’t spin through a vicious cycle of financial asset destruction, banking system dysfunction, and severe recession as occurred in 2007-9.  She needs to persuade investors that central banks, including the Fed, have the tools and flexibility to handle problems of too little economic growth, excessive disinflation, and deficient bank liquidity.  She needs to acknowledge that the Fed considers changed circumstances since the December rate hike to be meaningful with suggesting that a big irreversible policy mistake was committed at that time.  Yellen needs reassure markets that officials take the assignment of preserving financial stability seriously.  She may be asked what lessons monetary officials have learned from the handling of the Lehman Brothers collapse in September 2008.

In one respect, the U.S. economic prognosis is better than eight weeks ago, and that is because the dollar has reversed some of its prior appreciation against other advanced economy currencies.  However, that can be fleeting.  In fact, one ordinarily would expect to see a stronger dollar amid the extreme risk aversion of the past two months.  The paradox is explained by oil, which on a week-to-week and day-to-day basis continues to set the tone for all other markets.  Because the U.S. is a significant producer, the plunge in oil prices is problematic for the U.S. economy in ways that Japan and much of Europe are not. 

Copyright 2016, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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