Editor's Note: This is a special Hedgeye Guest Contributor note written by Mike O'Rourke. Mike is the Chief Market Strategist at JonesTrading where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.”
Is it a James Bond femme fatal? No. A US presidential candidate? No.
With her comments today during a video conference with minority bankers after the close, Fed Chair Janet Yellen proved she is the most dangerous woman in the world. At the conference, a participant posed this question –“If the Fed had legal authority to purchase equities how would that option impact monetary policy if at all?”
Here is Yellen’s response in its entirety:
“Well that’s a great question because I did mention in my remarks at Jackson Hole that the Federal Reserve is more restricted in what assets it can purchase than many central banks around the world. For example, now the Bank of Japan is purchasing equities and corporate bonds and the European Central Bank is also purchasing corporate bonds. So these purchase programs work by trying to produce a more accommodative set of financial conditions that will improve spending. In our case when we buy what are long term safe assets, long term treasuries and long term mortgage backed securities, we’re directly pushing down longer term interest rates. We want to make sure borrowers generally face more accommodative conditions and that would include corporate borrowers. Now because Treasury securities and corporate securities and equities are substitutes in the portfolios of the public. When we push down yields let’s say on Treasuries there is often and typically spillover to corporate bonds and to equities as well that those rates fall or that equity prices rise stimulating investment. But we are restricted from investing in that wider range of assets and if we found, I think as other countries did that they reached the limits in terms of purchasing safe assets like longer term government bonds it could be useful to be able to intervene directly in assets where the prices have a more direct link to spending decisions. Now, I don’t think this is something we need now. When I raised it back in Jackson Hole it was speculative but we do find ourselves now in a slower growing global economy. One where unfortunately productivity growth has been slow and economists are coming to the conclusion that the general level of interest rates going forward is likely to be lower than it has been historically and that means if our economy were hit by a negative shock and the Fed needed to intervene to stimulate the economy we have less room using our conventional overnight interest rate tool to do that. So many researchers are thinking about what other tools might be useful to have on the shelf for the future in case we need a wider range of tools. While it is a good thing to think about it is not something that is a pressing issue now. I should emphasize that while there could be benefits to the ability to buy equities or corporate bonds there would also be costs as well that would have to be carefully considered in deciding if that is a good idea.”
That long winded response is a world apart from the concise answer she provided lawmakers on Capitol Hill yesterday when she noted the Fed could not purchase equities. Today’s comments sound like the words of a Central Banker who would like to have this authority. Despite this being a relatively low profile event, the gravity of her words are on par with Ben Bernanke’s 2002 speech “Deflation: Making Sure "It" Doesn't Happen Here” which set the stage for the Quantitative Easing response to the crisis in 2008.
Yellen's rationale for such power defies logic and reality. Her case is so poorly constructed that it is easy to dismantle almost line by line. Since when are the Bank of Japan, and European Central Bank the standard for superior monetary policy? Even more remarkable is that those economies serve as examples of this policy failing. She mentioned the need to make sure corporations have accommodative credit conditions. Credit conditions for corporations cannot get much more accommodative than they are today in the United States.
Yellen once again admits to fueling the bubble in financial markets including equities when she said “When we push down yields let’s say on Treasuries there is often and typically spillover to corporate bonds and to equities as well that those rates fall or that equity prices rise stimulating investment.” The spillover created is not fundamental improvement, it is simply pushing up the asset prices. It may stimulate stock market purchases, but it does not stimulate investment in the real economy. The type of real investment that Fed officials are always pining about having disappeared.
She sticks with the bubble theme admitting the Fed is simply hoping for a wealth effect “... it could be useful to be able to intervene directly in assets where the prices have a more direct link to spending decisions.” This could be one of the most irresponsible statements ever spoken by a central bank head. In essence, she is saying that when the chips are down and the economy is in a bad way, the Fed’s last hope is that a wealth effect leads to increased spending. Chair Yellen, markets don’t work that way. They will play along with your games when things are going good, but they will unmercifully punish you when the environment weakens to the point where your game can’t be sustained.
Recall that the S&P 500 dropped an additional 25% in the little more than 3 month period after QE was launched. Yellen then refers back to Jackson Hole and how economic conditions have changed. “When I raised it back in Jackson Hole it was speculative but we do find ourselves now in a slower growing global economy.” Jackson Hole was a month ago, and the only thing that has changed is the view of Federal Reserve officials. The rest of us have been well aware how slow the economy is, both in the US and abroad. Those policies at the BOJ and ECB must be working great ... She notes “…economists are coming to the conclusion that the general level of interest rates going forward is likely to be lower than it has been historically.” Once again, this is the view of Fed officials changing, not the reality of the economy or the market changing.
What is clearly lost is that the US currently has all of these conditions that Chair Yellen desires. Credit conditions are accommodative for corporations. Stock prices are approximately 2% from their all-time high and bond yields are near an all-time low. The wealth effect has been both historic and massive. Household Net Worth is up more than 30% from its 2007 peak and more than 60% from its 2009 low.
Despite having all of these qualities that such a policy would deliver, we do not have the economic growth the Fed or anyone else seeks.
Furthermore, Yellen just warned that the environment is much worse than she and her colleagues at the Fed previously believed. We have not even gone down the path of highlighting the dangers that occur when you crowd private investors out of the markets and they choose to cash in their chips rather than participate in crony capitalist fictitious markets. These words have the tenor of a Central Banker who knows she has created multiple bubbles and is desperate to have tools to respond when the bubble pops.
And we all know that a desperate person is a dangerous person.