Market Verdict on Yellen Shows Fed Transparency Comes With Costs

Janet Yellen’s greeting in financial markets during her first press conference as Federal Reserve chair highlights the hazards of too much communication, investors said.

Selling accelerated in equities and bond yields jumped just after 3 p.m. New York time yesterday as Yellen told reporters that the interval between the end of quantitative easing and the first increase in the fed funds rate might be “around six months.” It was more than she needed to say, according to Donald Selkin of National Securities Corp. and Philip Orlando of Federated Investors Inc.

“The words were poorly chosen,” Selkin, who helps manage about $3 billion as chief market strategist at National Securities in New York, said in a telephone interview. “She handled it a little clumsily. It was a shock as she was always considered more on the dovish side.”

Adding press conferences after policy statements was one of Ben S. Bernanke’s biggest efforts to improve the Fed’s connections with the public and demystify the institution, which as recently as 1993 didn’t announce its monetary-policy decisions. Bernanke said in 2011 that the central bank was weighing benefits of more transparency against the risk that his remarks would trigger unwanted market fluctuations.

Greenspan’s Way

Alan Greenspan described his approach after becoming Fed chairman in 1987 to a congressional committee: “Since I have become a central banker, I have learned to mumble with great incoherence,” adding: “If I seem unduly clear to you, you must have misunderstood what I said.”

It’s a point Yellen should take to heart, said Orlando, who helps oversee almost $400 billion as chief equity-market strategist at Federated Investors.

“She learned a valuable lesson not to be specific when answering reporters’ questions,” Orlando said in a phone interview. “She needs to learn to be more Greenspan-esque, more ambiguous. Greenspan would never have answered that question.”

Published at 2 p.m. in Washington, the Federal Open Market Committee statement repeated that the rate will stay low for a “considerable time” after asset purchases end. Asked how long that might be about an hour later, Yellen said: “you know, this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing.”

Condition Dependent

She added that “it depends on what conditions are like,” and that if inflation “is persistently running below our 2 percent” goal, that would be “very good reason to hold the funds rate at its present range for longer.”

Inflation measured on a 12-month basis has been below the Fed’s 2 percent goal for almost two years, and prices rose just 1.2 percent for the year ending January. The Standard & Poor’s 500 Index went from down about 0.3 percent to down 1.2 percent in the minutes after Yellen’s response.

Yields on two-year notes, the government securities most sensitive to changes in interest-rate expectations, began to rise after the Fed released a summary of economic projections that showed the median estimate by officials was for the fed funds rate to move to 1 percent in December 2015 and 2.25 percent a year later. The estimates in December were 0.75 percent and 1.75 percent respectively.

Two-year yields jumped further after Yellen began the press conference, reaching the highest level since September and capping the biggest one-day gain since 2011. That sparked a selloff in bonds around the world.

Bernanke Signals

The market reaction was similar in May and June when predecessor Bernanke first signaled that curtailment of Fed bond purchases could happen in 2013, Michael Shaoul, chairman and chief executive officer of Marketfield Asset Management LLC, which has more than $20 billion, said by phone.

The S&P 500 lost 0.8 percent on May 22 from a record high after Bernanke’s comments. It went on to tumble 5.8 percent through June 24.

“You’ve got to allow markets to go down 50 to 60 basis points sometimes,” Shaoul said today by phone. “Yellen did a fine job yesterday. She’s not a stranger to capital markets. They are used to hearing her voice. But the timing of her takeover here is difficult.”

The press conference format makes uncertainty more likely, according to Stephen Wood, the New York-based chief market strategist at Russell Investments.

No Mistake

“I don’t think it was a mistake or a sign of a dramatic shift in Fed policy, it was more a function of an imprecision in language in an informal interview environment,” Wood, whose firm oversees about $257 billion, said by phone. “There are things you say in a conversational way that are different from what you would say in a prepared remarks kind of way.”

Interest rates on money-market derivatives to short term Treasury debt rose yesterday as traders viewed an increase in fed officials’ projections for the path of the main policy rate and Yellen’s comments as more hawkish than expected.

Derivatives traders using contracts that speculate on the path of the federal funds rate brought forward by one month, to June 2015, the time they expect the central bank to first lift its target rate for overnight loans between banks.

Implied yields on federal funds futures traded at the CME Group Inc. exchange now signal a 62 percent probability the Fed will first increase its target rate in June 2015, up from 42 percent yesterday morning, according to calculations available on the exchange’s website.

Fed Funds

The implied yield on the fed funds futures contract that expires in December 2015 contract is now 0.79 percent, compared with 0.64 percent yesterday morning. The implied yield, which is calculated by subtracting the quoted price from 100, on the December 2016 futures is now 1.89 percent, up from 1.61 percent just prior to the completion of the FOMC meeting yesterday. The futures are based on expectations for the average during the contract month of the fed effective, a volume-weighted average on trades by major brokers published by the New York Fed.

The timeframe that Yellen suggested was “more aggressive” than the market consensus for when rates will rise, according to Edward Marrinan, a macro credit strategist at RBS Securities in Stamford, Connecticut.

“Risk takers who were in ‘risk-on’ mode may now step back and decide for themselves whether Ms. Yellen meant what she said or whether she misspoke on her views of the timing of the first rate hike,” Marrinan said. “I can’t help but feel that if she had said ‘six to 12 months’ instead of ‘around six months’ that the market reaction would not have been as pronounced.”

Changed Focus

The reaction reflects perceptions that the Fed has changed its focus from boosting employment to limiting inflation, according to Jerome Schneider, head of the short-term strategies and money markets desk at Newport Beach, California-based Pacific Investment Management Co. Whether or not Yellen’s communication is to blame, now it’s up to her colleagues to limit the damage, he said.

“We have to now be aware of what kind of clarification comes from Fed speakers over the next few days,” Schneider said in a phone interview. “It was pretty clear what Yellen stated and the market took her at her word. But the clarification will be key in terms of what’s going forward.”

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