Janet Yellen's Testimony
As Janet Yellen makes her semi-annual congressional address, John Authers and Dan McCrum examine how the markets could react.
Janet Yellen, chair of the Federal Reserve, has reminded Congress that the institution planned 3 rate rises this year, and they may well be back on the table as soon as March, in what many people would call a hawkish statement. To talk us through the market reaction, why and what it means, we're joined by John Authers, the FT's chief investment commentator.
The story of the reaction, that's obviously by far the most straightforward important response we've had is that the 10-year treasury yield shot up very quickly. On the statement, I think the critical points are that she went out of her way to remind, even in her prepared remarks, that she didn't want to raise rates too late. If you left it too long, then you might have to raise them more later on. There was also a lack of conditionality at this point. They were expecting inflation to hit target, reminding how much the unemployment picture is improved.
Finally, she also made it clear that this had nothing to do, this wasn't conditional on what we get in the terms of fiscal policy. So obviously if we get a really big tax cut, if we do get big spending on infrastructure passed, that would increase even from there, the chance of a rate rise. So I think it's quite plainly correctly perceived as a hawkish statement.
And this is a bit of a reversal for markets, isn't it? This idea of rate rises were coming soon has sort of been ebbing out of the market in recent weeks.
Yes, I think that's fair to state. We'll take a look at this chart here, which is the Fed funds futures market. This is the market where people can trade with each other to hedge bets on when rate rises are coming. And you can see that the chance of a rise next month peaked as far as the Fed funds futures market was concerned, just at the end of last year, and was pegged back from somewhat over 1 in 3 to a little under 1 in 4. We've seen a sharp rise. I think that's completely justified on the basis of what we've heard from Janet Yellen.
It's still not, I would say, maybe because I tend to think that the signs of inflationary pressure are a bit stronger than other people do, I would say the chances really are a good strong 50/50 at this point. I don't think you say the kinds of things she said as a central banker unless you really, really strongly want to reserve the right to raise rates imminently.
And is there a chance the market is still behind the Fed here? I think we were looking at this earlier. There's a 50/50 chance of the 3 hikes.
Yes. Well, you've got to remember last year, the Fed started out saying there were going to be 4 rate rises. And the market, at that point, started out betting that there was about a 50/50 shot that there'd even be 1. And the market was right. We got 1 rate rise in December. And there has been a long history of the Feds trying to convince the market that it really might raise rates, and the market not believing it.
One of the very interesting things-- whether you want to credit Donald Trump with this, I'm not sure-- but you do see the markets coming together with the Feds quite sharply and quite suddenly over these last few months. There is still, though, a desire by the markets, really even more of a Goldilocks scenario, that we can have our growth, but don't have to put up with the higher interest rates that go with it. If you take a look at the stock market, there might be another interesting way of looking at this.
Where are we with the Trump trade?
Well, the Trump trade is-- I would argue that we've had a pause in the Trump trade, i.e. this belief that we really are going to get reflation and the things that go with reflation, such as higher rates. If there's one sector that benefits from higher rates, it's financials, because it improves their profit margins. There's one sector that has a problem with high rates, it's utilities. Heavily-regulated people buy them for their dividend. Their dividend becomes less attractive. You can get a decent rate from bonds.
You can see again, obviously a very clear cut belief in the market that this means higher rates relatively imminently. It hasn't meant an overall big fall in the market, at least so far as we speak. There is still no great fear that anything the Feds does is really going to choke off growth or really going to require people. And again, I find this questionable, given the kind of valuations we're having, which on many levels are at historic highs. There's not a belief that this is going to mean that you need to cut down the valuation multiples that you pay for your stocks.
So faith in Trump, faith in stocks, and modestly higher interest rates.
Thank you, John.