Yellen's Masterful Bond-Market Puppet Show
Federal Reserve Chair Janet Yellen has proved to be amazingly adept at giving speeches that are widely open to interpretation, giving everyone a little of what they want to hear without shocking the markets.
At the same time, she has also managed to subtly shift the market toward where she wants it to go.
On Tuesday, in a speech Cleveland, she demonstrated this ability by saying both that the Fed "should also be wary of moving too gradually" with tightening policy but offsetting that by admitting that the central bankers may be overestimating the U.S. economy. Traders initially seemed to take note of the hawkish tilt, slightly pushing up yields on two-year U.S. Treasuries, which are now at the highest level since October 2008.
The dollar also strengthened slightly against its peers, possibly on the prospect of more aggressive policy tightening by the U.S. central bank. Both moves were dampened as Yellen answered questions and demonstrated her typical tempered approach to assessing the nation's growth.
At the same time, a big minority of investors seem to think the central bankers will be forced to slow down and reassess their approach because of a weaker-than-expected U.S. economy. Some will point to the narrowing yield curve to prove this; the gap between yields on 30-year and two-year Treasuries, for example, shrank further, to the least since 2007.
Either way, there has been one clear reaction by bond traders: Implied chances of a December interest-rate increase by the Fed rose after already increasing considerably over the past several weeks. They reached nearly 70 percent in the wake of Yellen's comments from as low as 22 percent earlier this month, according to trading in futures contracts tracked by Bloomberg. This is making it easier for the Fed to go ahead and make another move this year despite the somewhat inconclusive U.S. economic data.
The big takeaway is not that the Fed is omniscient or has some grand unstated plan. It is that Yellen is a masterful puppeteer of the $14 trillion U.S. Treasury market. She has honed a knack for giving it just enough information to tilt it in the direction that seems appropriate to her without causing a massive jolt. As President Donald Trump leans against reappointing Yellen to another term, it's worthwhile to appreciate this finesse. It will likely be sorely missed come next year.
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