Tuesday, February 11, 2014 - Yellen: Far From Complete

Yellen: Far From Complete

by Sinclair Noe

DOW + 192 = 15,994
SPX + 19 = 1819
NAS + 42 = 4191
10 YR YLD + .04 = 2.71%
OIL + .36 = 100.42
GOLD + 15.90 = 1291.90
SILV + .16 = 20.34

Janet Yellen went to Capitol Hill this morning to deliver her first semi-annual Monetary Policy Report to Congress as Fed Chair; this is what we used to call the Humphrey-Hawkins testimony and it involves prepared remarks followed by a question and answer before the House Committee of Financial Services; tomorrow, she’ll repeat the process with senators.

With regard to monetary policy, Yellen said she expects a great deal of continuity in the FOMC's approach to monetary policy. No surprise; Yellen was the vice-chair, she served on the FOMC, she helped formulate the current monetary policy strategy, and she supports the strategy.

Yellen pointed to real gross domestic product growth which rose at an average annual rate of more than 3.5% in the third and fourth quarters, versus 1.75% in the first and second. She also said there has been “progress” in the labor market which has added 3.25 million jobs since the Fed began a new round of asset purchases in August 2012.

However the economy added just 113,000 jobs last month, and 75,000 jobs the month prior. While Yellen did not specifically reference these weaker than expected reports in her prepared remarks, she called the labor recovery “far from complete.”

And the Fed’s target of 6.5% unemployment as the line where they might pull back from their zero interest rate policy; turns out that 6.5% is more of a threshold than a trigger, and Yellen made clear that the FOMC is “considering more than the unemployment rate when evaluating the condition of the US labor market.” Yellen also said she was surprised by the most recent jobs reports from December and January although she thought weather might be a factor, and she admitted the recovery is far from complete.

In addition to the headline unemployment rate, the Fed is trying to figure out what to do with long-term unemployed workers and part-time-but-wannabe-full-time workers. The numbers may not reflect what people’s preferences are, but that the economy can’t absorb them yet.  In the Q&A, she said: "A significant part of the decline in labor force participation is structural and not cyclical. Baby boomers are moving into older ages where there is a dramatic drop off in labor force participation…” In other words, get used to the new normal.

And then she tossed the jobs issue back into Congress’ court: "For our part we are trying to do what we can, with monetary policy, to simulate a faster economic recovery to bring unemployment down nationally.... Monetary policy is not a panacea. I think it's absolutely appropriate for Congress to consider other measures that you might take in order to foster the same goals.... Certainly all the economists that I know of think that improving the skills of the workforce is one important step that we should be taking to address those issues."

The key moment in the Q&A session was probably when Yellen said a notable change in the outlook will be cause for a change or a pause in the tapering stance. Wall Street traders loved that line. And then she talked about what it would take for the Fed to jump back into more bond buying: “I think a significant deterioration in the outlook, either for the job market, or concerns, very serious concerns, that inflation would not be moving back up over time. But the committee has emphasized that purchases are not on a preset course, and we will continue to evaluate the evidence."

When Yellen was asked about the consequences of QE, specifically bubbles, she answered: “I think it's fair to say our monetary policy has had an effect of boosting asset prices. We have tried to look carefully at whether or not broad classes of asset prices suggest bubble-like activity. I have not seen that in stocks, generally speaking. Land prices (she was referring to farm land), I would say, suggest a greater degree of overvaluation."

And Yellen added: "We recognize that in an environment of low interest rates like we've had in the Unites States now for quite some time, there may be an incentive to reach for yield. We do have the potential to develop asset bubbles or a buildup in leverage or rapid credit growth or other threats to financial stability. Especially given that our monetary policy is so accommodative, we are highly focused on trying to identify those threats."

Of course, the Fed’s dual mandate is price stability and maximum employment, but they also work as bank regulators, and her answer about her role as a regulator was informative; you have to listen carefully to the nuanced role of the Fed as regulator: "To my mind, the regulatory agenda of trying to strengthen the financial system will bring important long-term benefits to the economy."

We talk about the big banks behaving badly, and so when we see what looks like recognition of the problems by an actual banker, well that’s noteworthy. Today in the Guardian, Ross McEwen, the CEO of RBS admitted the British megabank abused its customers during the financial crisis: "In the rush for growth and profit, RBS forgot what banking is about. The bank valued least the people it should have valued most: its customers. We sold them products like PPI which many didn't need, and in some cases didn't know they had. Our customers often felt confused by language they found difficult to understand. We wasted their time with needless bureaucracy. We literally and metaphorically put them at the back of the queue."

And if you’re wondering what the reference to PPI is about, PPI stands for Payment Protection Insurance. PPI was sold, often using misleading sales practices, alongside personal loans and other borrowing, including credit cards. The policies were meant to cover payments if customers were sick or unemployed, but often they did not pay out or the buyer did not qualify in the first place. The four biggest British banks, Lloyd’s, Barclays, Royal Bank of Scotland, and HSBC have set aside close to $35 billion in legal reserves to pay for abuses related to PPI.

McEwen took over as CEO of RBS in October. The letter is one that could serve as a template for bankers here in the US; Janet Yellen and her colleagues at the Fed should read it as well. Some of the other key points from McEwen include: “Openness breeds trust.” And, “RBS cannot start to claim to be a bank that always treats people fairly unless we stop doing those things that erode trust. We cannot start to claim we are renewing the bank unless we stop shirking our responsibilities to our shareholders – principally the British taxpayer.”

McEwen has announced a detailed plan within the next month. This will be fun to watch this story unfold. McEwen is not representative of all big bankers; just today, Barclays announced it would fire 12,000 employees over the next year and at the same time they are raising the bonuses for their investment bankers; and they also announced profits had dropped 13%.

Yesterday we told you House Republicans were going to meet to work out their strategy for raising the debt ceiling. They met last night. House Speaker John Boehner laid out a plan to link the debt ceiling increase to legislation that would have reversed a cut to veteran retirement benefits, but conservative Republicans opposed the plan because it did not include provisions to pay for the erasing the cuts in veterans retirement benefits and Republican leaders worried that Democrats would not go along, holding firm to President Obama’s demand that no policy attachments come with a debt ceiling increase.

The debt ceiling is the maximum amount the Treasury Department may borrow to pay for spending programs that Congress has already authorized. Up until the last several years, the majority party in each chamber had taken the responsibility of raising it. And then Speaker Boehner changed the protocol with something he called the “Boehner Rule”, which holds that any debt ceiling increase should be attached to spending cuts of equal size; that set off a series of standoffs resulting in a sequestration deal in 2011 and last year's government shutdown. Nobody wants that again, and so now Boehner has told the Democrats to bring the debt ceiling to a vote; a clean bill with no attachments; and he’ll muster a couple dozen Republican votes to assure passage.

And that takes us back round to Janet Yellen’s earlier comments about the economy; you will recall she said: “Monetary policy is not a panacea. I think it's absolutely appropriate for Congress to consider other measures that you might take in order to foster the same goals.” There is plenty Congress could do, but I think we all know that isn’t going to happen.

So where does that leave us when it comes to investing?  The economy is still weak, the recovery is fragile at best, payroll data missed expectations in December and January, you can only blame the weather for a part of the market reaction (an ice storm in Atlanta has nothing to do with Treasury notes that mature in 10 years), corporate profits continue to outpace corporate revenue, top line and bottom line don’t jibe, at some point the divergence will lead to a tipping point, at some point stocks need to pay attention to the reality on the ground. The recent four day rally just feels like a trap being set. QE failed to juice the economy because it  was stimulus misdirected to the banks and not to Main Street; Yellen will back away from QE because it isn’t working; it may have stabilized the  financial sector but it failed to stimulate inflation expectations or economic activity, and the whole experiment is getting too risky.

Yellen is right to say we need fiscal policy to guide the way but she is wrong to imply that monetary policy can’t do more and better; monetary policy could make a big positive change; unfortunately that’s not going to happen.