The Daily Prophet: Yellen's Word to the 'Unwise'

Connecting the dots in global markets.

Federal Reserve Chair Janet Yellen and the bond market may finally be getting in sync. Traders pushed the odds of an interest-rate increase next month to 34 percent from 30 percent after Yellen told the Senate Banking Committee in her semiannual report on monetary policy that waiting too long to further tighten monetary policy “would be unwise.”

That's a departure from much of the past two years, when traders would normally yawn whenever Yellen said policy makers considered every meeting "live" when it came to rate hikes. Of course, it didn't help her cause that the Fed only boosted rates twice in that period. The bond market is on edge these days after data showed an uptick in wage gains, leading traders to price in a faster pace of inflation. Higher bond yields mean increased borrowing costs are on the way for companies and consumers.

"The broad picture is that inflation is more likely to rise than to fall on a core basis over the next one to two years," Joachim Fels, the global economic advisor at Pacific Investment Management Co., said on Bloomberg Television's Daybreak Americas. "The market is not fully priced for that rise in inflation."

Dollar bulls embraced the prospect for higher rates in the U.S. as soon as next month. The greenback erased its losses and rose following Yellen's remarks on speculation that they would draw investment from yield-starved international investors. After a rough January, the greenback has regained some of its footing this month, posting its first weekly advance of the year last week. A trader in London said,Yellen was the trigger for a market that may have been short dollars, according to Bloomberg News' Dennis Pettit. Amherst Pierpont Securities LLC Chief Economist Stephen Stanley described Yellen's words as “easily the most hawkish message” that she has delivered as Fed chair.

The U.S. stock market rose again today, setting another record, thanks to optimism that higher rates will fuel earnings growth for financial firms. Goldman Sachs Group Inc. jumped to $249.46, passing a record close set in late 2007, just before Wall Street plunged into a crisis that almost brought down the global financial system. That's the good news. The bad news is, strategists don't seem convinced the rally is worth jumping into at the moment. A monthly survey of 18 Wall Street analysts revealed that the consensus year-end estimate for the S&P 500 Index is 2,350. That's unchanged from January's survey and means the benchmark, which closed today at 2,337.58, is less than 1 percent away from the forecast. Sell in February and go away?

China’s major state-backed banks tend to splurge at the start of the year as they seek to maximize profits on lending, but this January they were particularly active. China added more credit last month than the equivalent of Swedish or Polish economic output, with aggregate financing climbing to a record 3.74 trillion yuan ($545 billion). That exceeded the median estimate of 3 trillion yuan in a Bloomberg survey. New yuan loans rose to a one-year high of 2.03 trillion yuan. The surge in credit only serves to underscore the challenges facing Chinese policy makers as they seek to balance ensuring steady growth with curbing excess leverage in the financial system.

The euro has had a terrible month, and a Bloomberg index tracking the shared currency against a basket of leading global peers has fallen 2.26 percent. Besides all the hand-wringing over euro zone politics and the possibility of anti-euro parties gaining power, now comes news the economy is weaker than first thought. Gross domestic product rose 0.4 percent in the three months through December, the European Union’s statistics office in Luxembourg said on Tuesday. That is below the Jan. 31 estimate of 0.5 percent. Fourth-quarter output fell short of forecasts in Germany, Italy and the Netherlands, three of the region’s five-largest economies. 

Most economists were in agreement that Yellen's comments suggested that by not raising rates again soon, the central bank risks not being able to contain inflation. Federal Reserve Bank of Richmond President Jeffrey Lacker implied as much during a Q&A session at an event in Newark Delaware, saying policy makers run the risk of being "behind the curve." That probably puts extra attention on Wednesday's consumer price index report. The consensus is for the measure, excluding food and energy, to rise 0.2 percent for January, and 2.1 percent from a year earlier.     

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