Yellen Revealing Twists With No Turns
Vice Chairman Janet Yellen says the end of the Federal Reserve’s so-called Operation Twist won’t amount to a tightening of monetary policy. Whether investors agree may help determine the central bank’s next steps.
The Fed’s program to swap $400 billion of short-term securities in its portfolio for longer-term debt is scheduled to be completed in June, and Yellen, 65, doesn’t see the need for additional stimulus purely to blunt the impact. That’s because the measure eases policy by expanding the Fed’s balance sheet, not through the flow of purchases, she said April 11.
If the Fed refrains from further easing and Operation Twist ends without jolting markets, that would “absolutely” boost central bankers’ confidence in the economy, said Jim Paulsen, chief investment strategist at Wells Capital Management. Fed officials, who meet April 24-25, are considering keeping monetary policy on hold as the U.S. shows signs of strength following record accommodation.
“Ultimately the market is going to come to the decision that this thing can survive without emergency assistance,” Paulsen, who helps oversee about $325 billion, said in an interview from his Minneapolis office.
He predicts the Fed won’t undertake additional bond buying. “I suspect it’s winding down, and the next discussion is going to be ‘Shouldn’t they start normalizing?’”
Thirty-eight, or 76 percent, of 50 economists in a Bloomberg News survey conducted from April 18 to 20 thought the end of Operation Twist would result in an increase of 0.25 percentage point or less in 10-year Treasury yields.
Members of the Federal Open Market Committee upgraded their assessment of the economy at their March meeting and called for more easing only if the expansion “lost momentum” or if inflation stays below their 2 percent inflation target, the minutes showed. Since then, growth has continued, with gains in the labor market, sales and consumer confidence.
Yellen, Chairman Ben S. Bernanke’s top lieutenant in Washington for a year and a half, and Federal Reserve Bank of New York President William C. Dudley gave little indication in speeches this month that a third round of large-scale asset purchases is imminent.
“If we were to end the maturity-extension program in June as currently planned and not to announce further actions beyond that, I would not see that as a tightening of policy,” Yellen said in response to an audience question after an April 11 speech in New York.
The Fed completed two bond-buying programs totaling $2.3 trillion in June. Dudley played down the prospects for a third round of so-called quantitative easing, saying in Syracuse, New York, on April 12 that it might “create more anxiety on the part of some that it would lead to future inflation.”
No Sign of Withdrawal
Still, he and Yellen endorsed the central bank’s plan to keep borrowing costs low through late 2014, again giving no sign the Fed is ready to withdraw any of its stimulus. Yellen, who has spent most of her career teaching economics and researching labor markets, said she considers “a highly accommodative policy stance to be appropriate,” given unemployment will decline “only gradually.”
While the jobless rate has fallen to 8.2 percent from 10 percent in October 2009, it’s still well above the Fed’s 5 percent to 6 percent estimate for full employment.
“The Fed’s staying on hold, and they’re just going to be cautious,” as “there are a lot of good signs and some negative signs,” said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “That’s why a lot of these speeches by Fed governors appear to be frustrating to so many people,” because investors would like “accelerating economic growth” not the current moderate expansion.
Stocks fell on April 3 after the minutes from the March 13 meeting dashed expectations for more Fed stimulus, kicking off a five-day decline in the Standard & Poor’s 500 Index. (SPX) The S&P 500 then climbed 1.4 percent on April 12 after Yellen and Dudley’s remarks reinforced the perception that borrowing costs will remain low.
“The Fed’s in a difficult position, as I know everyone wants to see 3, 3 1/2, 4 percent growth, but that’s hard for the Fed to generate when so many of the issues,” such as fiscal cutbacks and the crisis in Europe, are outside its control, Silvia said. He estimates the economy will expand at a more moderate pace of about 2 percent to 2.5 percent.
Silvia predicts the Fed will wrap up Operation Twist without new stimulus, and he doesn’t see “a big reaction whatsoever” in the market. Yields on 10-year Treasuries may rise no more than 25 basis points, he said.
The Fed’s bond buying has succeeded in driving down borrowing costs, with the yield on the benchmark Treasury note falling to an all-time low of 1.67 percent on Sept. 23, two days after Operation Twist was announced. Yields since have climbed to 1.96 percent as of April 20 on improvement in the economic outlook.
Not all investors are convinced the end of Operation Twist will be a nonevent. Pacific Investment Management Co.’s Bill Gross still predicts the Fed will use its balance sheet for more stimulus as growth weakens.
“Without QE, the financial markets and then the economy will falter,” Gross, who oversees the world’s biggest bond fund, wrote in a Twitter post on April 4.
Should Gross’s prediction prove correct and investors react adversely, the Fed probably would add to its stimulus, according to John Lonski, chief economist at Moody’s Capital Markets Group in New York.
“The Fed has put itself in a position where it is ready to respond quickly if the market or the economy moves in a direction to its disliking,” Lonski said. “Suppose, okay, the Operation Twist expires and we suddenly have the 10-year Treasury soaring above 2.5 percent. My sense is the Fed would not hesitate to do something to bring fixed-rate borrowing costs lower.”
Lonski said it’s “premature” to assume the Fed is done easing, given weakness in the housing market and the “disappointing reading” in the March jobs report.
Sales of previously owned homes unexpectedly fell in March for the third time in four months, dropping 2.6 percent to a 4.5 million annual rate, because of stricter lending standards, lower home values and the threat of more foreclosures.
U.S. employers added 120,000 workers last month, the fewest in five months and less than the most pessimistic estimate in a Bloomberg News survey of economists. Unemployment slid to 8.2 percent from 8.3 percent in February as people stopped looking for work, bolstering Bernanke’s view that declines overstate gains in the labor market.
‘No Good Reason’
“I see no good reason to doubt that our nation’s high unemployment rate indicates a substantial degree of slack in the labor market,” Yellen said in the April 11 speech. Yellen, President Bill Clinton’s chief economist in the 1990s, said the Fed is “quite willing and committed to take whatever actions are necessary” to achieve its goals.
The former San Francisco Fed chief stopped short of calling for additional stimulus. The labor market still has “shown welcome signs of improvement,” said Yellen, who joined the University of California-Berkeley in 1980. She and her husband, George Akerlof, a Nobel Prize-winning economist, have written more than a dozen papers that included studies on unemployment, wages, street gangs and out-of-wedlock births.
“My reaction to Yellen’s statement is the Fed does feel more confident that the economy has sustaining growth going forward,” Silvia said. “They’ve thought about this and said, ‘If we backed away, what do we get?’”
Expanding U.S. Economy
The U.S. will expand at a 2.3 percent pace this year, compared with 1.7 percent in 2011, according to a Bloomberg News survey of 75 economists conducted from April 6 to April 11. That was up from a median forecast of 2.2 percent in the March survey.
Retail sales have added to signs that growth is strengthening, with last month’s 0.8 percent gain almost three times as large as projected, according to Commerce Department data released April 16. Consumer confidence also is holding up, with the Bloomberg Comfort Index at minus 31.4 in the period ended April 15, matching the highest level in four years.
Economic data in the second quarter probably will be strong enough to keep central banks around the world from repeating the 40 interest-rate cuts and more than $1 trillion in asset purchases they’ve pursued in the past six months, Michael Hartnett, chief global equity strategist at Bank of America Merrill Lynch in New York, wrote in an April 10 report. That may portend a tougher period for asset prices, he said.
The International Monetary Fund raised its global growth forecast last week, increasing its prediction to 3.5 percent this year and 4.1 percent in 2013. The Washington-based IMF estimated in January that the world economy would expand by 3.3 percent for 2012 and 4 percent next year.
The effect of more than 1 trillion euros ($1.3 trillion) in long-term loans from the European Central Bank also is fading. Having offered banks in December and February as much money as they wanted for three years, the ECB has resisted a third such offer or adding other stimulus. Bank of England officials also are debating whether to bring their stimulus to a halt, as some of the nine Monetary Policy Committee members toughen their stance about the threat of inflation.
Hartnett and his colleagues envisage a “bad Goldilocks” period in which growth is neither “cold” enough to provoke more quantitative easing nor “hot” enough to prompt investors to rotate from bonds into equities or commodities.
Between March 31, 2010, when the Fed concluded its first quantitative easing, and August 27, 2010, when Bernanke signaled it might restart, the S&P 500 Index fell 9 percent. It’s up 18 percent since Operation Twist was announced Sept. 21.
“There’s certainly a cadre of market participants who worry that this thing has just been a sugar-high and once you take that away, can it stand on its own?” Paulsen said. “There’s gathering evidence it’s taking on more of a self- sustaining character. The best thing the Fed could do would be to stand down.”
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