Thank you, Janet Yellen! You didn’t disappoint me. You are still the “Fairy Godmother of the Bull Market!” As I’ve noted many times before, the S&P 500 tends to rise after Yellen speaks about the economy and monetary policy. The S&P 500 soared 4.5% on Wednesday and Thursday in response to the dovish FOMC statement and Yellen’s bullish press conference.

On Wednesday, I wrote:

However, the plunge in oil prices and the turmoil in the junk bond market might increase the likelihood that the Fed will delay the so-called "lift-off" of interest rates beyond mid-2015. "None and done" in 2015 is a distinct possibility for Fed policy. Let’s see what Fed Chair Janet Yellen has to say later today. I’m counting on her to continue to be the "Fairy Godmother of the Bull Market.”

On Tuesday, I wrote, “The FOMC might surprise us and keep ‘considerable time’ in the statement.” I noted that inflationary expectations are falling. I also wrote:

The distress in the junk bond market might also dissuade the FOMC from changing the "considerable time" language. In any case, Fed Chair Janet Yellen’s press conference on Wednesday afternoon could have a big impact on the markets. I’m still betting that she is the "Fairy Godmother of the Bull Market.”

On Monday, I noted that FRB-Chicago President Charles Evans, one of the Fed’s uber-doves, has called on his colleagues to be patient and to delay raising interest rates.

Wednesday’s FOMC statement confirmed my analysis:

Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, 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.

The FOMC remains dovish and patient. It will be even more dovish and patient next year when Evans will be a voter. Two of the three dissenters (Richard Fisher and Charles Plosser) were hawks, who are retiring. The FOMC has to be concerned about the financial stresses caused by the plunge in oil prices and the strength of the dollar, as evidenced by the spike in junk bond yields and the selloffs in the bonds, stocks, and currencies of emerging economies. That’s why they are willing to be patient for a considerable time longer.

(Based on an excerpt from YRI Morning Briefing)

The Fed has three choices, as I’ve discussed in the past. Normalization would be great in theory. In reality, the odds increasingly favor “none and done,” more so than even “one and done.” While the labor market warrants tightening sooner rather than later, inflationary expectations are falling fast as oil prices plunge and the dollar strengthens.

On October 13, FRB-Chicago President Charles Evans gave a speech titled “Monetary Policy Normalization: If Not Now, When?” Back then he said:

Looking ahead, I am concerned about the possibility that inflation will not return to our 2 percent PCE target within a reasonable period of time. First, the recent monthly inflation numbers have been low, so there is not much upward momentum. Second, as I mentioned earlier, wage growth has been relatively low for some time. While wages don’t predict future inflation, the two often move together. And, third, it does not appear as if inflationary expectations are exerting much of an upward pull on actual inflation at the moment. ...

To summarize, I am very uncomfortable with calls to raise our policy rate sooner than later. I favor delaying liftoff until I am more certain that we have sufficient momentum in place toward our policy goals. And I think we should plan for our path of policy rate increases to be shallow in order to be sure that the economy’s momentum is sustainable in the presence of less accommodative financial conditions. I look forward to the day when we can return to business-as-usual monetary policy, but that time has not yet arrived.

(Based on an excerpt from YRI Morning Briefing)

FRBNY President Bill Dudley gave a speech on Monday titled, “The 2015 Economic Outlook and the Implications for Monetary Policy.” His views matter because he is on the FOMC and reflects the views of the dovish majority of the committee. He and Fed Chair Janet Yellen tend to have nearly identical views. Here are a few highlights of his speech:

(1) In general, he paints a reasonably positive picture of the economy and says, “if my own forecast is realized, I would expect to favor raising the FOMC’s federal funds rate target sometime in 2015.”

(2) He says that several of the “headwinds” restraining US economic activity in recent years have subsided. The housing industry is in better shape. So are consumers. There is much less fiscal drag. Financial conditions are good: “Equity prices are high, borrowing costs are low, cash flows are strong and corporate balance sheets are healthy.”

(3) Lower energy costs should “lead to a significant rise in real income growth for households and should be a strong spur to consumer spending.” He adds that in the aggregate, “the swing from oil producers to consumers is quite large. For example, a $20 per barrel decline in global oil prices results in an income transfer of about $670 billion per year from producers to consumers.”

(4) On the other hand, he doesn’t expect a boom. He doesn’t see much upside from the current levels of housing starts and auto sales. The global economic slowdown and stronger dollar could weigh on US exports.

(5) Despite the drop in oil prices and the strength of the dollar, he expects that the core PCED inflation rate will move back towards the Fed’s target of 2% next year as resource utilization tightens.

(6) He agrees with market expectations that the Fed will start raising the federal funds rate around mid-2015. However, he is also willing to be patient:

Finally, given the still high level of long-term unemployment and the outlook for inflation, there could be a significant benefit to allowing the economy to run "slightly hot" for a while in order to get those that have been unemployed for a long time working again.

(7) The pace of tightening will depend on the response of the financial markets:

If the reaction is relatively large--think of the response of financial market conditions during the so-called "taper tantrum" during the spring and summer of 2013--then this would likely prompt a slower and more cautious approach. In contrast, if the reaction were relatively small or even in the wrong direction, with financial market conditions easing--think of the response of long-term bond yields and the equity market as the asset purchase program was gradually phased out over the past year--then this would imply a more aggressive approach.

(8) Though all this implies that Fed policy is market dependent, Dudley then denied that the markets’ reactions matter:

Let me be clear, there is no Fed equity market put. To put it another way, we do not care about the level of equity prices, or bond yields or credit spreads per se. Instead, we focus on how financial market conditions influence the transmission of monetary policy to the real economy. At times, a large decline in equity prices will not be problematic for achieving our goals. For example, economic conditions may warrant a tightening of financial market conditions. If this happens mainly via the channel of equity price weakness--that is not a problem, as it does not conflict with our objectives.

Sorry, he lost me there.

(Based on an excerpt from YRI Morning Briefing)

The dramatic rebound in stocks around the world since October 15 once again demonstrates the overwhelming influence of the central banks on global equity markets. The Greenspan and Bernanke Puts have morphed into the puts of the major central bankers. As a result, they’ve made shorting stocks a losing proposition. Underweighting stocks simply because they are overvalued based on historical metrics also has been problematic for conservatively inclined institutional investors, who must at least match if not beat their benchmarks. Consider the following recent chronology of central bank interventions that have boosted stock prices:

(1) Bullard bounce. On Thursday, October 15, the dramatic rebound in stock prices from their lows was triggered by a comment by FRB-St. Louis President James Bullard that the Federal Reserve should consider extending its bond-buying program, currently at $15 billion per month, beyond October due to the market selloff--allowing more time to see how the US economic outlook evolves. Yet in his interview with Bloomberg News, Bullard also said he still believes that the FOMC should start raising the federal funds rate in March of next year.

Then after the FOMC meeting in late October, Bullard praised the Fed’s decision to end the bond purchases. He reiterated that he favors starting to raise interest rates next spring, ahead of the mid-year consensus among his FOMC colleagues. In an interview summarized in the 11/20 WSJ:

Bullard attributed some of the confusion to the fact that many market participants didn’t listen closely enough to what he said. He allowed that monetary policy making has become far more complex and thus more challenging to communicate. But he underscored an underlying consistency to his view, noting what he said about the Fed’s bond-buying program hadn’t altered his long-running view that short-term interest rates should be lifted off their current near zero levels next spring.

(2) Kuroda shock. On Friday, October 31, in a surprise move, the Bank of Japan (BOJ) stated that it is upping the ante on the QQE monetary stimulus program that was announced on April 4, 2013. The BOJ’s press release raised JGB purchases to an annual pace of 80 trillion yen from 50 trillion yen. The pace of buying was tripled for both ETFs (3 trillion yen) and J-REITs (90 billion yen). At the current exchange rate, ETF purchases would amount to about $27 billion. That’s not that much given that the market capitalization of the Japan MSCI is $2.7 trillion currently. So what’s all the excitement about?

The latest program is open-ended, according to the latest press release: “The Bank will continue with the QQE, aiming to achieve the price stability target of 2 percent, as long as it is necessary for maintaining that target in a stable manner.” The time horizon for achieving this goal was about two years in the 2013 press release.

On Friday, November 21, Japan’s finance minister told a news conference that the speed of the yen’s recent decline was “too fast.” He added, “There is no doubt about that.” Last Tuesday, November 25, the minutes of the October 31 meeting of the BOJ's governing board showed that the hurdle to further quantitative easing is high. Some board members were concerned that expanding the central bank's quantitative easing could raise the risk that it would be seen as financing the government deficit.

(3) Draghi’s pledge. On 10/11, Bloomberg reported that ECB President Mario Draghi told reporters in Washington that expanding the ECB’s balance sheet is the last monetary tool left to revive inflation, although there is no target for how much it might be increased. He said, “I gave you a kind of ballpark figure, say about the size the balance sheet had at the start of 2012.” That would be a remarkable increase of €1.0 trillion. On 11/21, in a keynote speech in Frankfurt, Draghi said that the ECB will “do what we must to raise inflation and inflation expectations as fast as possible.” In effect, he backed US-style quantitative easing.

Speaking in Finland on 11/27, Draghi said that the Eurozone needs a comprehensive strategy including reforms by governments to get it back on track. His comments and weak CPI data released on Friday lowered the euro to $1.246 and triggered a new set of record-low bond yields for the Eurozone's biggest economies, with France’s 10-year yield dropping below 1% for the first time.

The Eurozone flash CPI estimate rose just 0.3% y/y in November, down from 0.4% in October. Bank loans to nonfinancial corporations fell €132.0 billion (saar) during October, the ninth consecutive monthly decline, and the 26th in 27 months.

(4) Chinese rates. The People's Bank of China cut its benchmark one-year loan interest rate on Friday, November 21, to 5.6% from 6.0% and cut its benchmark one-year deposit rate to 2.75% from 3.00%. The nation's central bank also hiked the upper limit on deposit interest rates to 1.2 times the benchmark rate from 1.1 times the benchmark rate. The bank said that it took the actions, which were largely unexpected and are the first such changes since July 2012, in response to expensive borrowing costs rather than any direct worries about the economy's slowdown. Chinese bank loans rose 13.2% y/y during October, the weakest growth since November 2008.

(Based on an excerpt from YRI Morning Briefing)