Comment: Yellen to take refuge in economic data as Trump storm approaches
By Ipek Ozkardeskaya, senior market analyst at London Capital Group.
On Tuesday, Federal Reserve Chair Janet Yellen will deliver her first Humphrey Hawkins testimony in Washington DC since Donald Trump became the President of the United States.
Testifying before the Senate has always been challenging for the Fed chairmen, but the task has certainly become even more demanding, given the sharp and hectic shift in the US’ fiscal policy in a very short period of time.
It is fair to say that Trump is quite an unusual president and he has already gave a good shake to the financial markets even before he officially took office in January.
As such, Yellen needs a solid plan and strong rhetoric for the future of her monetary actions and she has a particularly slippery playground under her feet.
Reflation rally is the main theme in the US markets
Trump’s victory in November immediately triggered a reflation rally in the US stock markets. The US sovereign yield curve shifted significantly higher; the 10-year yields reached 2.60% before stabilizing at 2.30-2.50% in early 2017.
The so-called reflation rally is still on and the rational behind this rally is simple: Trump would adopt a sizeable fiscal stimulus program to create jobs, to revive the US economy and to ‘Make America Great Again’.
As such Trump announced a gigantic fiscal plan, including 500 billion US dollars worth of infrastructure spending and ‘phenomenal’ corporate tax cuts.
Although the sharpness of Trump’s actions and the lack of details have regularly infuriated and discouraged investors, his victory on 9 November has been a significant game changer for the Fed because such a gigantic shift in the US’ fiscal policy has been a significant boost for the US’ inflation expectations and the markets have forcefully reacted, if not overreacted to the ‘reflation’ idea.
Data is the safest refuge as the Fed lacks evidence to recalibrate its monetary policy.
Today, Janet Yellen is asked to deal with a highly complex political and financial situation. In fact, fiscal and monetary policies go hand in hand.
After inflation expectations spiked following the Trump victory, the Fed has already raised the Fed funds rate by 25 basis points at its December meeting and signalled a significantly tighter future for the US monetary conditions.
In this respect, Janet Yellen announced that investors should prepare for a steeper interest rate normalisation in years ahead, hinting at approximately 3% hike in Fed funds rates by 2018.
In fact, if Trump policies boost the inflationary pressures across the US as anticipated, the Fed would need to adopt a stricter monetary policy to prevent the US economy from overheating.
The problem is that the amplitude of the upcoming fiscal policy is rather unclear. We now know that corporate tax cuts should be "phenomenal", yet the Fed sure needs more elements to seize the impact of the looming stimuli
This is way, it is certainly too early for Janet Yellen to hint at the timing of the second rate action, as the Fed itself needs more data to base its next action on.
The markets give very low probability for a March action and Janet Yellen will likely bypass the March meeting to gather more and relevant data as the Trump policies are brought to life. Therefore, it is highly likely that Janet Yellen will again accentuate the importance of the economic data, simply to buy more time to base her monetary policy on a hopefully more solid ground.
As a consequence, we could well see Yellen confused and overcast before the Senate Banking Committee on Tuesday and the House Financial Services Committee on Wednesday.
Should Yellen’s speech lack a solid insight, the disillusion could flourish another wave of comfort rally in the US stocks and the dollar.