Janet Yellen on Capitol Hill: The Fed's Communications Problem

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

On the back of their best week of 2014, U.S. stocks managed to finish ahead on Monday – modestly -- with the benchmark S&P 500 index and the narrower Dow Jones Industrial Average (DJINDICES: ^DJI  ) rising 0.16% and 0.05%. With the earnings season beginning to wind down, investors are beginning to return their focus to that other critical driver of stock prices. Not valuations, of course – who wants to focus on such fuddy-duddy fundamentals? I'm speaking instead of the Federal Reserve and expectations for monetary policy, of course.

On Tuesday, new Fed Chief Janet Yellen will face her first major test as she sits before Congress for her first of two days of testimony regarding monetary policy. However, before she has even uttered a single word, Yellen's Fed already has a communications problem.

In an article published on Monday by the Federal Reserve Bank of San Francisco (the same bank Yellen used to head), Jens Christensen, a senior economist at the bank, argues that in the months leading up to the Fed's December decision to begin tapering its bond purchase program, investors brought forward their anticipated date for the first interest-rate rise significantly -- even though "Fed policymakers made few changes in their projections of appropriate monetary policy." The author's analysis, which is based on the Treasury yield curve, suggests that the expected time until the first rate rise went from two years in September to 15 months by late December, putting the first rate rise around spring 2015.

If investors aren't listening to the Fed's projections for the first interest-rate increase, that's a genuine problem for the central bank as it winds down its asset purchases (a.k.a. "quantitative easing"), since the process of communicating its expectations for the federal funds rate, known as forward guidance, will become the main policy lever.

Of course, the fact that bond market participants' expectations for a rate rise weren't the same as Fed policymakers' doesn't mean that bond traders aren't listening to the Fed, as such; instead, it could indicate a difference of opinion regarding when the Fed will ultimately begin to raise rates. After all, the Fed's projections are just that -- policymakers themselves do not know with any certainty when they will decide to raise, as the decision depends on many dynamic factors (unemployment, economic growth, inflation, and so on). Nevertheless, any difference of opinion in this area will make it harder for the Fed to do its job.

Part of the problem may be that the Fed's current framework for forward guidance, which ties the first interest rate rise to the unemployment rate has become essentially irrelevant. The Fed had said it would consider raising rates once the jobless rate fell to 6.5%. Last Friday, the Labor Department's January employment report showed an unemployment rate at 6.6%. The Fed updated its guidance in December, saying it expected to maintain rates at zero "well past the time" the unemployment rate falls below 6.5%. Considering that we are almost at the threshold now, that's simply stating the obvious at this stage.

Professional investors -- in bonds and equities alike -- will be following Yellen's testimony carefully this week, looking for some guidance on the current state of the Fed's guidance. For long-term, value-oriented investors, however, it is enough to remember that while the Fed's slow withdrawal of its arsenal of unconventional monetary policy measures could produce bouts of substantial stock market volatility, its monetary acrobatics will have little impact on long-term stock market returns.

Forget the Fed: Make one great stock investment in 2014
There's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2833437, ~/Articles/ArticleHandler.aspx, 11/22/2014 11:03:49 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement