Janet Yellen testified in front of the Senate Banking Committee
today and overall, there were few surprises. It is becoming clear that she
intends to continue most of the Bernanke Fed's policies, and to be honest I
couldn't find anything she would do differently. Her reception was generally
good, and the Senators were respectful. Most of the questioning had to do with
banking regulation, income inequality, the existence of asset bubbles and the
size of the Fed's balance sheet.
Here are some of the discussion points:
On current monetary policy: The Fed is seeking a
strong and robust recovery, and must not jeopardize it by removing accomodation
too early. She does not want to remove support while recovery is fragile. It is
costly to withdraw accomodation or fail to provide adequate accomodation, and
the Fed has the tools and the will to withdraw accomodation at the right time.
On asset bubbles: The Fed
should attempt to detect asset bubbles when they are forming, however the first
line of defense should be regulatory. Monetary policy is a blunt
instrument and should be used if other measures aren't working. She won't rule
out using monetary policy to address bubbles, but prefers that we use
regulatory measures (such as increased capital requirements, higher risk
retention requirements, etc) to prevent bubbles from occurring.
Separately, she sees little evidence that there are bubbles currently
forming in the real estate market.
On banking regulation: Too Big To Fail imposes costs on
the economy and should be avoided if possible. The government is making
progress in handling too big to fail. They will raise capital standards further
and the Fed is looking at requiring banks to issue additional unsecured debt at
the holding company level to raise capital. She wants to ensure that the system
isn't set up to advantage the larger banks at the expense of the smaller
banks.
On communication: In a nod to the volatility of
the bond market over the summer, she said that she wants the Fed to communicate
as clearly as possible with the markets and will redouble efforts to reduce
volatility. This follows Bernanke, and is a departure from the Fed of the past,
where they wanted to be as opaque as possible, lest the market anticipate what
they were going to do, which would limit the effectiveness.
On QE and the balance sheet: Yellen was asked
repeatedly about the effects of QE. She stressed that QE is being done to help
the economy, not to help the government finance its deficit. When pressed about
the size of the Fed's balance sheet, she was forced to admit it is
unprecedented for the US Central bank, but it was not unprecedented compared to
other central banks. She acknowledged there are costs and risks to such a large
balance sheet, and opposes any sort of Congressional audit of the Fed lest it
reduce the Fed's independence.
On income inequality: The Democratic Senators pretty
much focused on income inequality, and what could be done about it. Yellen
acknowledged that asset prices are rising, and that primarily benefits the
rich, however the point of QE is to help the economy recover, and the best
thing we can do for the middle class is to have a robust economy. She also
acknowledged that QE is doing a number on seniors who rely on interest from
safe assets to supplement social security. She views income inequality as a
serious problem.
On the dual mandate: She stressed that the Fed must
prevent inflation that is too low, and that deflation is a terrible thing. She
refused to say what she thought "full employment" was, other than to
give a range that it is probably in the 5% to 6% range. She also said that
fiscal policy was working at cross purposes with what the Fed is trying to do.
She also acknowledged that the reported unemployment rate understates the
severity of the problem.
Key Takeaways:
While not admitting it, she seems to indicate the Fed goofed
when it talked about withdrawing accomodation last June and causing the
subsequent bond market sell-off. Expect the Fed under Yellen to be more
communicative and she will probably try and clear up the confusion over
tapering QE. It certainly seems she intends to err on the side of caution,
provided there is no evidence of asset bubbles and inflation is at or below its
2% target rate.
The comment about full employment being in the 5% to 6% range
was interesting as well. We spent many years over the past couple of decades
with unemployment under 5% (it actually got below 4% in 2000). Does that mean
the Fed will begin to start tightening before it ever gets to that level?
Perhaps.
On asset bubbles, she does not hold the view that the Fed had a
role in inflating the real estate bubble or the stock market bubble. Those bubbles
were due to regulatory failure. It is ironic that the Fed has a problem with
"too much money chasing too few goods" - in other words
"inflation", but is ok with "too much money chasing too few
assets" - in other words a bubble. This is unsurprising; and suggests that
the punch bowl might hang around a little longer than expected.
Brent Nyitray, CFA
Director of Capital Markets
iDirect Home Loans
National Asset Direct
Dellacamera Capital Management
1010 Washington Blvd, 6th Floor
Stamford, CT 06901
203-817-3614 (w)
917-841-4938 (c)
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