Yellen stays ‘middle of the road’ on hikes
If high valuations and uncertainty about Donald Trump’s policies aren’t enough to cause a pullback in equity markets, a surprise Fed rate hike in March might be.
Federal Reserve chair Janet Yellen’s semi- annual testimony to Congress didn’t provide any revelations about the central bank’s plans for monetary policy, but with markets still pricing in relatively low odds of a March hike, investors are eager for clues about the path ahead.
Acknowledging that further hikes are coming and the risks associated with waiting too long, as usual, Yellen referred to the need to evaluate the economy at upcoming meetings.
Her use of the plural on “meetings” was noteworthy, as it allowed for mention of a March hike to be left out of the statement.
“Yellen’s testimony comes after a meeting at which the FOMC chose to stand pat, so her attempt to walk down the middle of the road should come as no surprise,” said Avery Shenfeld, chief economist at CIBC Capital Markets. “Nothing really hawkish in this, but markets have been pricing in very low odds of a March hike, and might at least have a more open mind on that until we see the next payrolls report.”
The Fed raised its benchmark interest rate by 0.25 per cent in December, and revealed that it expects three more such moves in 2017.
But it was only the second hike in a decade, and came after the Fed projected four rate increases in 2016. As a result, skepticism about whether the central bank can follow this year is warranted.
The U. S. economy is, however, on much more solid footing now that external factors such as low oil prices have faded, and worries about the election have passed.
“Whether it is ultimately one, two or three- plus rate increases, the recent run of hot economic data raises the question of whether the Fed should start early, perhaps with a March hike,” said Eric Lascelles, chief economist at RBC Global Asset Management.
He pointed out that while the Fed holds eight meetings each year, only four are accompanied by press conferences, which make policy changes easier to explain and digest.
Without a March hike, Lascelles noted that the Fed would be forced to pack its remaining three desired tightening operations into the only three remaining “major” meetings.
So while the economist is doubtful the Fed will move at its March 14-15 meeting, he thinks a hike is possible given the recent batch of good data and rising inflation.
Policymakers have to weigh the high level of policy uncertainty related to President Trump, and the possibility of having to raise rates quickly if they wait too long.
As Yellen stated on Tuesday, an extended delay could cause disruption in financial markets and drive the U. S. economy toward recession.
Rather than taking this as an imminent warning related to March, Derek Holt, head of capital markets economics at Scotiabank, sees it as a comment about not letting the economy run hot in the near term, and create further imbalances over time.
He insists there is nothi ng new in t his respect when compared to Yellen’s previous guidance, as both the Fed chair and other Fed speakers have stated this many times.
“If the Fed wishes to hike i n March then i t has an awful lot more work to do given its strong preference for having markets almost perfectly priced for such an outcome to avoid surprises,” Holt said.
He expects the Fed will use the March meeting to build more momentum for a June hike that markets appear more prepared to accept.
Holt also noted that if Yellen wanted to tee up the possibility of a hike next month, she may have considered not using the term “meetings.”
Markets don’t like surprises, and they are already starting to price in higher odds of March hike, rising to roughly 35 per cent from closer to 20 per cent in recent weeks.
Even though Yellen noncommittal about the timing of a rate hike, bond yields j umped on her prepared comments, and the U. S. dollar rose.
“It would have been unusual for her to rule March out of the Fed’s deliberations despite the weak wage numbers seen at the beginning of the month,” said Michael Hewson, chief market analyst at CMC Markets.
It’s also worth noting that Yellen seemed to distance herself from the shift in Fed projections toward three hikes at the December meeting. As a result, any signal of a March hike would be a significant shift in posture.
Clearly the market isn’t ruling out the prospect of a Fed move in March, and with the central bank itself keeping its options open, investors shouldn’t be surprised if things change in the next few weeks.
North American equity markets sold off after the December hike and Fed projections for 2017. So if March starts to look more likely, the pace of expected rate increases might start to pick up once again, and stocks could lose some lustre.