Dec 17/15 – Yellen’s dovish reputation is undeserved…

2015-12-17 12pm EDT  |  #bonds #Federal Reserve #US dollar #Yellen

This past summer, Christine Lagarde`s IMF urged the Federal Reserve not to tighten until 2016. At the time, I felt her public stance was counter productive. The last thing the Fed wants is to be seen taking orders from the IMF. Yet Lagarde’s public statements continually warned of the dangers from a tighter Federal Reserve:

IMF Managing Director Christine Lagarde said the risks of raising rates too soon — and wounding the economy before it’s reached full strength — outweigh the risks of waiting a bit too long and allowing inflation to creep up.

“The economy would be better off with a rate hike in early 2016,” Lagarde said at a press conference.

Well, Janet Yellen proved she is her own woman yesterday as she finally went ahead with the Federal Reserve’s first rate hike in almost a decade.

I know everyone thinks Janet is some sort of super dove, but if you examine her track record since taking office as the head of the Federal Reserve in February of 2014, she has done nothing but tighten. She held fast with the tapering of QE, ushering in the eventual end of Federal Reserve balance sheet expansion by the summer of 2014. She introduced programs to soak liquidity out of the system through reverse repos and term deposit auction securities. Since taking office, the US 2 year note yield has risen from a little under 0.30% to almost 1%.

And almost to the day when the Fed bought their last bond, the US dollar has exploded higher under Yellen’s watch.

There are a bunch of old school pundits who believe Yellen should have moved even more quickly in her tightening campaign. But their beef is probably more with Bernanke than Yellen. When you examine the pace of tightening of the short end of the yield curve and the US dollar, I would argue Yellen is actually moving too fast. During the period from 2008 to 2014, the American economy had been subjected to an extraordinary amount of stimulus. To think Yellen could take over and normalize rates overnight is naive. These “old school” market watchers would have had Yellen raise rates even more quickly, causing an even greater rally in the US dollar and even more problems that have accompanied this rise.

Yet when you look at these charts, it is difficult to call Yellen dovish. Although she might talk a good game, her actions speak louder than words.

She has tightened almost as quickly as the market has allowed. Yellen has ignored pleas from the rest of the world to not tighten. She has methodically set about normalizing rates. Yesterday’s first rate hike was simply the next step in this process.

But make no mistake. This was far from the first hike. Remember the Wu-Xia shadow Fed Funds rate?

The shadow fed funds rate has headed straight up under Yellen’s leadership.

Yellen’s easy reputation is undeserved.

Given the length of time interest rates have been stuck at zero, I thought she would raise the Federal Reserve rate in the most dovish way possible, but I was wrong. There was absolutely nothing dovish about yesterday’s raise.

It looks as if Yellen will continue raising rates until something big breaks. We have seen cracks, but so far the FOMC has looked past these worries. The Federal Reserve and all the Wall Street strategists might be optimistic about the outlook for 2016, but I am not nearly as sanguine.

Smart shrewd guys like real estate tycoon Sam Zell are sounding the alarm bell. Yesterday on Bloomberg Zell said:

“There is a high probability that we are looking at a recession in the next 12 months. The strong dollar is having a tremendous impact on US production and US businesses.”

This is the fellow that pitched his entire real estate company at the absolute top of the mid 2000s economic boom. He picked off Blackstone with a panache that has forever made a Sam Zell fan. When Sam speaks, I listen. And there is little doubt he believes we are headed downward.

And it’s not just Sam. There are too many other smart guys warning about the dangers of Yellen’s policy to name. Well articulated concerns like Bridgewater’s Ray Dalio’s warning about a 1937 style policy error have faded to the background, but they really shouldn’t.

Don’t assume that just because the stock market went up yesterday after the Fed’s announcement everything is fine. It is far from it. It is only a matter of time before Yellen’s tight policies choke off growth in the US economy.

I would rather bet with Sam Zell and Ray Dalio than the unanimous rose coloured forecasters from Wall Street any day…

I know it is easier being in the majority with all these optimists, but the Federal Reserve is no longer a tailwind at your back. The market is assuming Yellen is way more dovish than her actions indicate.


No way to work this next picture into my writing, but it still made me laugh. I couldn’t resist a little editing, and including it in today’s post…

Thanks for reading,

Kevin Muir

the MacroTourist