On the standards by which these things are judged, Janet Yellen’s confirmation hearings went well, meaning markets rallied with little volatility.
Speaking before the US Senate Banking Committee, the nominee for Federal Reserve chairman was dovish, but not so much as to scare the horses.
“I consider it imperative that we do what we can to promote a very strong recovery,” Yellen, the Fed’s vice-chairman, told the committee.
Considering that the current recovery, though long in the tooth, has only produced tepid jobs growth and below-target inflation, a “very strong” recovery is going to require the continued administration of stimulants.
For risk assets, that was good but not unexpected news.
The S&P 500 rose half a per cent, and 10-year US government bond yields fell by a couple of basis points, or about 1 per cent. All in all a creditable performance in markets, especially considering Yellen has good reason to not appear too dovish ahead of her confirmation votes.
While Yellen gave the impression that she and the Federal Open Market Committee would certainly be considering tapering before too long, she didn’t seem to be in a great, tearing hurry about it.
“It’s important not to remove support, especially when the recovery is fragile and the tools available to monetary policy should the economy falter are limited,” she said.
“I believe it could be costly to withdraw accommodation or to fail to provide adequate accommodation.”
That statement is both true and perhaps a bit worrying.
Yellen is acknowledging that, as monetary policy is scraping at the lower bound of the possible, her arsenal is not well stocked.
At this point that arsenal would boil down to doing more of what you’ve already done (with mixed results) or saying you will do more, or doing it for longer, or doing it with less regard to the risks.
If the Fed did taper and found the economy listing into a recession, it could buy more bonds, it could buy other assets, as the Bank of Japan is doing, or it could pledge to buy bonds and hold rates lower for longer.
None of those is tried and tested, so the Fed has good reason, it seems, to let things run for a bit.
That probably means the Fed will not announce a taper next month.
March is the next logical target date. Yellen will be in the chair, and a press conference at which the reasons could be explained is already scheduled.
One thing we did not learn much about at the hearing is the possibility that the Fed introduces some new form of forward guidance, essentially promising to keep rates lower for longer, perhaps, as suggested in recent Fed research, by tying a rise to a move down in the unemployment rate to as low as 5 per cent.
Yellen did show some scepticism about the unemployment rate, acknowledging that it perhaps flatters the employment situation by undercounting discouraged workers.
The idea, though, of taking away bond buying slowly while softening the blow with forward guidance has some attractions.
Bond buying is not only unproven, it is a large redistribution of wealth upward, one which is having a diminishing effect on the real economy.
And, as Steven Englander, foreign exchange strategist at Citigroup, points out, there will be some real limitations on how long the Fed can carry on buying US$85 billion of bonds per month.
If the Fed carries on buying US$45 billion per month of Treasuries, it will be buying a large portion of all of the longer-dated debt the US issues next year. With the Fed already holding more than 40 per cent of the longer-term (five years maturity and over) Treasuries in existence, this leaves them open to charges that they are affecting fiscal policy and distorting the market.
So a taper, then, in March, with the Fed buying fewer Treasuries while pledging to keep rates lower for longer could, from several points of view, offer advantages. More of its firepower would be “reaching” Main Street, via subsidising mortgage borrowing and concentrating on employment.
That’s not to say this will work well, or is wise.
Forward guidance is a policy that rests on the premise that markets will believe what the Fed tells it, which is further premised on the idea that the Fed knows what it ought to tell markets.
Look at Britain, where the Bank of England has had to revise its forward guidance, bringing closer the date of an expected increase, after an unexpectedly (to the bank) quick recovery in employment.
The problem is the markets never believed the BOE in the first place and were pricing in a rate rise sooner than it was promising one.
The Fed arguably has both more power and credibility than the BOE but may find itself with both threatened if it relies too much on them as an easy tool.