Yellen Takes The Chair

Includes: DIA, QQQ, SPY
by: Alhambra Investment Partners

Janet Yellen gave her first testimony to Congress as Chair of the Federal Reserve. You'll notice a distinct lack of gender in that title, one that Ms. Yellen apparently prefers, and I don't disagree a bit with her choice. The gender of the person entrusted with maintaining the integrity of our money is quite irrelevant. After listening to the views she expressed in Congressional hearings last week though, I found myself wondering if we wouldn't have been better off with an actual chair in the position. At least a piece of furniture wouldn't have such a grandiose view of its purpose.

Yellen used most of her statement to ruminate about unemployment and how monetary policy would be adjusted in response to the health of the jobs market. Inflation was mentioned but only in passing and primarily in reference to its absence in the measures preferred by the Fed. The Fed does have a dual mandate, written into law in the late 70s when the Phillips curve and Keynesian economics reigned supreme, but writing it down and tasking the Fed with doing what Congress ought doesn't make monetary policy any more effective at fulfilling it. Yellen spoke eloquently about the plight of the long term unemployed and assured one and all that the policies put in place by her predecessor would remain. Left unsaid was how the next trillion of QE would accomplish what the last 3 most definitely didn't.

Monetary policy can affect unemployment in the short term when interest rates can be manipulated lower to spur borrowing and lending, spending and investment. Unfortunately, the interest rate lever is already fully extended and despite this encouragement to partake in a little hair of the dog, neither banks nor individuals seem much interested. Banks have no incentive to lend with real rates in negative territory (even with the fillip of interest on excess reserves) and individuals are tired of shopping for stuff they don't need and can't really afford. At the zero bound, monetary authorities have nothing left in their toolkit to affect hiring other than running up asset prices in the hopes that some of the lucre accumulating at the top will trickle down to those unburdened by capital gains.

The stock market seems perfectly content with that policy and Yellen gave them no reason to believe it will end if the economy doesn't cooperate with the Fed's growth desires. And so last week, as the flow of economic news continued its errant course of disappointment, bad news became good news for the stock market as speculators tried desperately to get ahead of the tapering of tapering that will no doubt come if Yellen doesn't get what she expects. The other explanation offered by numerous market pundits was that investors were "looking through" the bad data to a sunnier and warmer second half of the year - as they have every year of this "recovery". I'm not sure what kind of spectacles these folks are wearing but they give new meaning to the phrase "rose colored glasses".

The economic data has been almost uniformly negative since the beginning of the year and last week was no exception. Retail sales, industrial production, mortgage applications, jobless claims and business inventories were all reported to have moved in the wrong direction. Something else I've noticed recently was conspicuous in the reports - negative revisions to previous data. New releases are usually accompanied by revisions to the prior month and for the last few months they have been almost all negative. Retail sales that last month were reported as up 0.2% were downgraded to up 0.1%. November industrial production, originally reported as up 1%, is now in the record books at up 0.7%. When the economy is expanding robustly, the revisions tend to be up, not down-- so this is definitely a trend worth watching.

Weather has also been mentioned recently as a potential cause of the weak data and even Yellen made a passing reference to it when commenting about the last two sub par employment reports. Weather is certainly having an effect but auto and home sales were peaking before things got really cold; mortgage applications are down 13% year over year and started falling long before the frost hit the pea vine. I would also point out that the northern regions of the U.S. are usually pretty chilly this time of year. My daughter is going to grad school in Chicago (Go Maroons!) and based on my American Express bills, she seems to have acclimated just fine. Cold weather can also positively impact economic reports as it did industrial production in January when utility output rose 4.1%. Given that most economic reports are seasonally adjusted and it is always cold in the winter, I have a hard time buying the weather excuse.

Investors face tough choices made even tougher by the new Chair of the Fed. U.S. stocks are overvalued by every reliable valuation method and the high quality bonds that are the normal alternative offer piddling yields and cash even less. If the economy continues to weaken, will Yellen stop tapering QE? If so, what weight does she put on the weather as a factor in recent reports? Will she wait until spring arrives to assess the health of the economy? Was Punxsutawney Phil's declaration of six more weeks of winter the most important input for future monetary policy?

In short, I don't think anyone has a good idea, even after her testimony, as to how Janet Yellen will conduct monetary policy except that she will err on the side of doing something rather than nothing. Even if the something is to continue a policy that has failed miserably -unless you count another near trillion dollar pork laden farm bill as success.

It is unfortunate that monetary policy - and the people that inflict it upon us - has become so important to investors. The drift of the Fed from what should be its sole mission - a stable dollar - has now culminated in a Fed Chair who believes she has the power to solve problems that have nothing to do with monetary policy. I'm happy to see the glass ceiling shattered at the Fed, but the long term unemployed are not going to find jobs because Janet Yellen decides to add another few hundred billion to banks' excess reserves. In fact, if Yellen gets the same result as the last two Fed Chairmen, she will likely end up causing more harm than good. We'd be better off with a La-Z-Boy or a wingback.