Markets were caught off-guard by Fed Chairwoman Janet Yellen’s remarkably dovish speech before the Economic Club of New York this afternoon. Traders had been bracing for Ms. Yellen to echo the hawkish comments by several Federal Reserve regional presidents in the preceding week; as a result, the markets were caught wrong-footed by Yellen’s dovish remarks. One of those remarks was especially noteworthy, as it was an implicit promise to engage in a fourth round of quantitative easing (commonly called “QE4”) if the Fed thought the economy was foundering.
Masters of Mixed Messages
Five of the 12 regional Fed presidents (St. Louis Fed President James Bullard, San Francisco Fed President John Williams, Richmond Fed President Jeffrey Lacker, Philadelphia Fed President Patrick Harker, and Atlanta Fed President Dennis Lockhart) gave especially hawkish speeches and interviews last week, pumping up expectations of an April rate hike.
However, weak economic data yesterday may have reversed Yellen’s opinion on the health of the economy, especially due to a downward revision of the first quarter GDP forecast. The Atlanta Fed’s “GDPNow” forecast slashed Q1 growth from an initial 1.4% projection to a paltry 0.6%. Consumer spending was virtually flat while the trade deficit grew.
Yellen Plays Market Maestro
According to the transcript of Yellen’s speech posted by the Federal Reserve, the Fed Chair acknowledged risks facing the economy and her view that the central bank ought to “have considerable scope to provide additional accommodation.”
Here are some of the highlights:
“Given the risks to the outlook, I consider it appropriate for the Committee to proceed cautiously in adjusting policy. This caution is especially warranted because, with the federal funds rate so low, the FOMC’s ability to use conventional monetary policy to respond to economic disturbances is asymmetric.”
“Even if the federal funds rate were to return to near zero, the FOMC would still have considerable scope to provide additional accommodation. In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy—specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities.“
In response to this strong and unequivocal support for more quantitative easing, both stocks and gold spiked during afternoon trading on Tuesday. The Nasdaq led the way 1% higher while spot gold surged about 1.5% to above $1,240/oz. Meantime, the dollar appeared to “walk off a cliff,” plunging from unchanged to about 0.6% into negative territory in a matter of minutes.
Even though Chair Yellen’s speech directly contradicts what her fellow Fed governors have said in the preceding days, the possibility of more QE from the Federal Reserve does not come as a big surprise. While her comments certainly drove market activity on Tuesday, it’s always good to keep in mind that the Fed has an agenda to actively engage in this type of misdirection. Your best bet is to follow the fundamentals and vigilantly stay prepared for the worst.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.