Monday, June 23, 2014

The Fairy Godmother of the Bull Market
The Fairy Godmother of the Bull market did it again last week. Whenever Janet Yellen speaks publicly about monetary policy and the economy, stock prices tend to rise. On Wednesday, the S&P 500 climbed 0.8% to yet another new record high in response to her press conference that day. It rose 0.3% on Thursday and Friday to 1962.87. It would have to gain just 2.6% to reach my yearend target of 2014, which I am thinking about raising. However, a melt-up followed by a meltdown back to 2014 by the end of this year remains a distinct possibility.

Yellen’s pronouncements have tended to be bullish for stocks since she first took office as vice chair of the Board of Governors in October 2010. Now we can look forward to her quarterly press conferences as Fed chair, the position she assumed in February of this year. Of course, Fed policy has been ultra-easy since the start of the bull market, and stocks have also tended to rise after most FOMC meetings.

The stock market’s bulls were charged up last week by both the FOMC’s statement and Yellen’s spin on monetary policy. Consider the following:

(1) Unanimous. The latest statement was almost identical to the previous one on April 30. (See the WSJs Fed Statement Tracker.) Once again, the FOMC reaffirmed its NZIRP, or near-zero interest-rate policy:
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
Remarkably, the vote for the current policy stance was unanimous. No one dissented in favor of language suggesting that interest rates might have to be raised sooner given the ongoing improvement in the economy and the labor markets, as well as the recent rebound in inflation.

(2) Noisy inflation. Even more remarkable, when asked in her press conference about the recent inflation rebound, Yellen blew it off as noise. In her prepared remarks, she didn’t even acknowledge the recent broad-based upturn in inflation:
Inflation has continued to run below the Committee’s 2 percent objective, and the Committee remains mindful that inflation running persistently below its objective could pose risks to economic performance.
Last week, I noted that the core CPI, on an annualized three-month basis, rose from 1.4% during February to 1.8% during March to 2.2% during April to 2.8% during May. I expected some mention of this new inflation risk in the FOMC statement and Yellen’s press conference. Instead, it was like it never happened.

Indeed, Yellen’s response to the first question by CNBC’s Steve Liesman about the possibility that inflation might be on the verge of exceeding the FOMC’s 2016 target was bizarre:
So, I think recent readings on, for example, the CPI index have been a bit on the high side, but I think it's--the data that we're seeing is noisy. I think it's important to remember that broadly speaking, inflation is evolving in line with the committee's expectations. The committee has expected a gradual return in inflation toward its 2 percent objective. And I think the recent evidence we have seen, abstracting from the noise, suggests that we are moving back gradually over time toward our 2 percent objective and I see things roughly in line with where we expected inflation to be.
(3) Unemployment spin. In her prepared remarks, Yellen acknowledged that the labor market is improving, but accentuated the negatives rather than the positives:
The unemployment rate, at 6.3 percent, is four-tenths lower than at the time of our March meeting, and the broader U-6 measure--which includes marginally attached workers and those working part time but preferring full-time work--has fallen by a similar amount. Even given these declines, however, unemployment remains elevated, and a broader assessment of indicators suggests that underutilization in the labor market remains significant.
During the Q&A, Yellen added:
That said, many of my colleagues and I would see a portion of the decline in the unemployment rate as perhaps not representing a diminution of slack in the labor market. We have seen labor force participation rate decline.
She also noted that wage inflation is running around 2%, which is too low in her opinion. It’s barely keeping up with inflation and should be rising faster to reflect productivity. She is rooting for this to happen, and isn’t inclined to tighten monetary policy if and when it does.

(4) No thresholds. The Fed’s experiment with tying monetary policy to a specific threshold for two key indicators started at the December 11-12, 2012 meeting of the FOMC, when an unemployment rate of 6.5% was specified as the “threshold” for discussing raising interest rates as long as the inflation rate wasn’t still below 2%. The unemployment threshold was dropped at the March 18-19, 2014 meeting, the first one with Yellen as chair.

At her latest press conference, Yellen said that the FOMC has reverted to a fuzzier data-dependent approach:
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This broad assessment will not hinge on any one or two indicators, but will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.
(5) No bubbles yet. Yellen said she sees some signs of speculative excesses, and she is monitoring the low pace of volatility in financial markets, a sign of complacency. However, so far, she doesn’t see a need for monetary policy to respond to these developments, thereby contributing to the markets’ complacency!

Here is what she had to say about volatility:
The FOMC has no target for what the right level of volatility should be. But to the extent that low levels of volatility may induce risk-taking behavior that for example entails excessive buildup in leverage or maturity extension, things that can pose risks to financial stability later on, that is a concern to me and to the committee.
More specifically, she believes that the level of risk-taking remains “moderate”:
Trends in leverage lending in the underwriting standards there, diminished risk spreads in lower-grade corporate bonds, high-yield bonds have certainly caught our attention. There is some evidence of reach for yield behavior. That's one of the reasons I mentioned that this environment of low volatility is very much on my radar screen and would be a concern to me if it prompted an increase in leverage or other kinds of risk-taking behavior that could unwind in a sharp way and provoke a sharp, for example, jump in interest rates. …But broadly speaking, if the question is: To what extent is monetary policy at this time being driven by financial stability concerns? I would say that--well, I would never take off the table that monetary policy should--could in some circumstances respond. I don't see them shaping monetary policy in an important way right now. I don't see a broad-based increase in leverage, rapid increase in credit growth or maturity transformation, the kinds of broad trends that would suggest to me that the level of financial stability risks has risen above a moderate level.
(6) Complacent valuations. With regards to stock market valuations, she remains relatively complacent:
So I don't have a sense--the committee doesn't try to gauge what is the right level of equity prices. But we do certainly monitor a number of different metrics that give us a feeling for where valuations are relative to things like earnings or dividends, and look at where these metrics stand in comparison with previous history to get a sense of whether or not we're moving to valuation levels that are outside of historical norms, and I still don't see that. I still don't see that for equity prices broadly.
(7) Uber dove. Fed policy remains data dependent. However, Yellen is likely to describe the data as “noisy,” and therefore irrelevant if the numbers don’t support her ultra-liberal assessment of the disappointing performance of the economy and her preference for maintaining ultra-easy monetary policy until all ex-cons are gainfully employed. I wish I was kidding.

In her 3/31 speech in Chicago, she briefly described the struggle of three workers in the Windy City--Dorine Poole, Jermaine Brownlee, and Vicki Lira--in the labor market. On April Fools’ Day, Jon Hilsenrath reported in the WSJ:
One person cited as an example of the hurdles faced by the long-term unemployed had a two-decade-old theft conviction. Another mentioned as an example of someone whose wages have dropped since the recession had a past drug conviction.
Hilsenrath also noted that a Fed spokeswoman said Yellen knew of the people's criminal backgrounds and that they were “very forthright” about it in conversations with the chairwoman before the speech!

During last week’s Q&A, Yellen confirmed that she remains one of the FOMC’s most dovish members when she said, “inflation continues to run well below our objective, and we're still some ways away from maximum employment and for the moment, I don't see any tradeoff whatsoever in achieving our two objectives. They both call for the same policy, namely a highly accommodative monetary policy.”

Thank you, Madam Fairy Godmother! Fairy tales can come true, especially for us bulls.
(Based on an excerpt from YRI Morning Briefing)

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