Kristina Hooper, US investment strategist and head of US Capital Markets Research & Strategy for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
When you’re the head of the Fed, markets hang on your every word—for better or worse.
In her first press conference since becoming Chair of the Federal Reserve, Janet Yellen arguably created a bigger panic than if she had yelled “Fire!” in a crowded room. It was perhaps her first lesson in choosing her words carefully when fielding questions from reporters.
Yellen said that the federal funds target rate would remain in the 0-0.25% range for a “considerable time” after the Fed ended its asset-purchase program. However, when pushed for a more specific timeline, she estimated that it would be about “six months.” That triggered an alarm in the markets that was similar to last year’s taper tantrum, when markets overreacted to Ben Bernanke's comments on a timeline for paring its bond-buying efforts.
Disconnect the Dots
Similarly, we think that investors overreacted to Yellen’s words and to the “dots” in the FOMC announcement, which represent the forecasts of the Fed's Board of Governors and the 12 Fed district bank presidents. While Yellen defined “considerable time” as six months in her press conference, she stressed that only the official policy statement should be used as a guide to monetary policy. As for the dots, she dismissed them, warning against looking at the dots as an expression of the FOMC’s official policy stance.
Our key takeaway from Yellen’s remarks: The Fed hasn’t changed its monetary policy or its outlooks on inflation and employment. Although Yellen noted that labor-market conditions are stronger than anticipated in December.
Further, we think the markets have overlooked the bigger picture in that the Fed hasn’t just moved the goalposts, in terms of what will trigger a rise in the Fed funds rate, but changed them altogether. They’re now employing a broader set of measures that will dictate when rates rise, which is more dovish given the rate at which unemployment has fallen. In other words, as long as inflation remains well below target and the labor market continues to reveal slack, the Fed anticipates that policy will remain very accommodative. This confirms our view that the Fed will be looser for longer.
Misperception Is Reality
Nevertheless, the markets apparently felt that the FOMC took a turn towards a more hawkish stance. When it comes to capital markets, what investors think—right or wrong—can become a self-fulfilling prophecy. Defining six months as a “considerable amount of time” post-tapering to keep the Fed funds rate at its current level is significant, especially considering that some Fed watchers thought it would have spanned 18 months to two years.
Over time, that timeline may well be proven wrong. But the Fed funds futures immediately priced in the first 25-basis-point hike for March 2015 and that has yet to be reversed.
Still, investors shouldn’t get hysterical but instead get historical, as the past can help guide future allocation decisions. In recent periods of rising interest rates, we found a pattern of stocks initially dropping while Treasuries fell, but then when investors presumably adjusted to the rate change, stocks stabilized and then rose.
Investors should recognize that the highly accommodative monetary policy environment we’re in favors risk assets. And we expect this climate to continue for longer than what the market now anticipates. We also believe that once interest rates rise, there will be a lot of volatility for both Treasuries and stocks. But if history is any guide, after initial weakness stocks are likely to stabilize and then move higher as long as there is enough economic growth to support stock fundamentals.
Of course that could be becoming a bigger “if,” at least in the near term, as the FOMC modestly reduced its economic outlook last week. Look for economic data to continue to tell the story of this recovery and focus more on Fed deeds than Fed words.
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