Yellen Signals Continued QE Undeterred by Bubble Risk
Janet Yellen indicated she’ll press on with the Federal Reserve’s unprecedented monetary stimulus until she sees a robust recovery, downplaying risks the policy is inflating asset bubbles.
“I don’t see evidence at this point, in major sectors of asset prices, misalignments,” she said yesterday during her confirmation hearing to be the next Fed chairman. “Although there is limited evidence of reach for yield, we don’t see a broad buildup in leverage, where the development of risks that I think at this stage poses a risk to financial stability.”
Yellen signaled her determination to use bond buying to strengthen the economy and drive down the nation’s 7.3 percent unemployment rate. Testifying to the Senate Banking Committee as benchmark U.S. stock indexes rose to records, she sought to dispel concerns from senators that the central bank’s policy is pumping up the values of equities and housing to such an extent that it jeopardizes market stability.
“The possibility of there being a bubble isn’t going to keep her from doing more if she thinks that’s appropriate,” said Brian Jacobsen, who helps oversee $236 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “She sees no problem in doing more asset purchases” or even expanding them, he said.
Yellen, the Fed’s current vice chair, endorsed the strategies of Chairman Ben S. Bernanke, whose term at the central bank will expire in January. Bernanke has argued that the first lines of defense against instability in financial markets are regulatory tools, including the powers granted to the Fed under the Dodd-Frank Act whose final implementation would fall to Yellen if she’s confirmed.
European stocks were little changed today, with the Stoxx Europe 600 Index at 322.56 as of 9:30 a.m. London time. Standard & Poor’s 500 Index futures rose 0.1 percent.
The S&P 500 advanced 0.5 percent to a record 1,790.62 at the close in New York yesterday. The Dow Jones Industrial Average also increased to a record and the Nasdaq Composite Index added 0.2 percent to the highest since September 2000.
A 26 percent rally in the S&P 500 this year puts it on pace for the best annual gain in a decade and made shares more expensive, with the equity benchmark trading at 16.9 times reported earnings, compared with about 14.2 in January.
The S&P/Case-Shiller Composite Home Price Index climbed 12.8 percent in August from a year earlier for the steepest increase since February 2006. Blackstone Group LP, the world’s biggest alternative-asset manager, has spent $5 billion to acquire almost 30,000 U.S. single-family houses in a bet home prices will maintain gains.
“We’re now starting to see real-estate bidding wars just like the old days,” said Senator Mike Johanns, a Nebraska Republican. “We’re now starting to see private-equity firms, who I think are very good at looking where the economy is heading. And lo and behold, they are buying single-family houses.”
Yellen, 67, responded that many of those purchases are occurring in the hardest-hit housing markets such as Las Vegas and Phoenix where prices had collapsed. She said “we have to watch this very carefully, but I don’t see that as an asset bubble. I see that as a very logical response of the market to generate a recovery in very hard-hit areas.”
Some Fed officials have voiced concern that those low interest rates are overheating prices for assets including farmland, which could heighten risks when they reverse their bond buying. Asked yesterday about stock prices, Yellen said she doesn’t see “bubble-like conditions.”
“Stock prices have risen pretty robustly but if you look at traditional measures,” such as price-earnings ratios, “you would not see stock prices in territory that suggests bubble-like conditions,” she said.
While Yellen downplayed the threat of asset bubbles, regulators this year have taken four actions to lean against excessive risk in the market for high-risk, high-yield loans.
The Fed, the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corp. in March issued an advisory with specific guidance on risk management and underwriting standards. That action was followed by a cross-sectional review of the loans in the banking system, and then letters to individual banks. Fed officials then warned banks that they would be looking at the performance of the loans in the annual stress test.
Under questioning from Senator Robert Menendez, a New Jersey Democrat, Yellen said she would want to use tighter monetary policy to combat financial instability only as a last resort.
“That’s very much an argument that Bernanke has been making for a long time, that monetary policy is the wrong tool for dealing with bubbles,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore who worked at the Fed’s division of monetary affairs from 2004 until 2008.
The banking committee, consisting of 12 Democrats and 10 Republicans, plans to vote on Yellen’s nomination as early as next week, according to a banking committee aide. Her nomination would then move to the full Senate, where she’ll need the support of at least 60 senators to win confirmation.
“The committee seemed to bend over backwards, even the known critics of her and her boss’s policies, in their questioning,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “You could not see in the questioning any firm ‘no’ votes, and although there will be quite a few, it is looking more likely she will be confirmed.”
“I’ll be voting no,” Senator David Vitter, a Louisiana Republican on the Banking Committee, said in a statement after the hearing. Yellen made clear “she would continue the Fed’s current policies of continuing ‘Too Big to Fail’ and free money, quantitative easing, with no wind down in sight.”
Under two hours of questioning, Yellen said the benefits of the bond-buying program still outweigh the costs and said the best thing the Fed can do to combat income inequality is help the job market recover.
Tennessee Senator Bob Corker, a Republican who opposed Yellen’s nomination for Fed vice chairman in 2010 and has criticized the Fed’s policies as too stimulative, opened his questioning by highlighting Yellen’s record of supporting higher interest rates. Before becoming vice chairman, she served as San Francisco Fed president from 2004 to 2010 and was a Fed governor from 1994 to 1997.
Corker said that while he has philosophical differences with her, Yellen is “a very qualified person, very likable and very transparent and I do appreciate all those characteristics, so we’ll see.”
No Democrat has voiced opposition to Yellen’s confirmation.
Yellen said it’s “imperative that we do what we can to promote a very strong recovery.” She said “it’s important not to remove support, especially when the recovery is fragile and the tools available to monetary policy, should the economy falter, are limited given that short-term interest rates are at zero.”
Yet she also reassured senators that she does not see the era of low interest rates and quantitative easing continuing indefinitely.
“This program cannot continue forever,” Yellen said. The Federal Open Market Committee “is focused on a variety of risks and recognizes that the longer this program continues, the more we will need to worry about those risks,” she said.
Yellen also said that policy makers could reconsider whether to cut the interest rate it pays on excess reserves, currently 0.25 percent.
“It certainly is a possibility,” Yellen said. So far, U.S. central bankers have been concerned that lowering the rate would damage the functioning of the money market, she said.
The FOMC has held its main rate near zero since December 2008 and pledged to keep it there as long as the unemployment rate remains above 6.5 percent and the outlook for inflation doesn’t rise above 2.5 percent.
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