Everyone expects Janet Yellen to be a rolling over, inflationist stooge just like they did Ben Bernanke. Bernanke came on board after Alan Greenspan had taken the Fed Funds rate up to around 5% if I remember correctly. Inflationists and gold bugs thought they had it in the bag when 'Helicopter Ben' assumed control.
Indeed, Bernanke did what he was supposed to do (per the 'Helicopter 'Ben' script) as systemic stresses began to gather in 2007, addressing that pesky Funds rate, culminating in December, 2008's official ZIRP (zero interest rate policy). Here again is the chart showing the S&P 500's 'Hump #3' attended by this most beneficial monetary policy.
As noted again and again, the much trumpeted 'taper' of QE is not only not a negative for the economy, we have made a strong case that its mechanics are actually a positive, in the near term at least. But putting ZIRP on the table would be a whole different ball of wax.
We need to ask ourselves what kind of distortions the above chart represents, and what would be the implication of these distortions? The S&P 500 has, at the instigation of ZIRP formed a grand Hump #3 and yet this was done without the usual attendant rise in T Bill yields. In other words, the Fed has held ZIRP and continues to hold ZIRP, despite what Janet Yellen ruminated during her post-FOMC press conference:
How long after QE tapering ends will the Fed wait to raise the Funds Rate?
"So the language that we used in the statement is 'considerable period.’'So I, you know, this is the kind of term it's hard to define. But, you know, probably means something on the order of around six months, that type of thing." –Janet Yellen
Nothing has changed, other than a new Fed Chief was asked a provocative question and she bumbled along with an answer. Sort of.
The key questions are…
What sort of inflationary pressures have been built into the system as a result of a fully formed Hump #3 having grown along side still-ZIRPed monetary policy?
and…
Does this have inflationary or deflationary implications?
The answer is for all the marbles where investment (that benefits from inflationary cost effects) or non-investment (cash) are concerned.
Again, as part of the above linked post, we have noted that an incentive is built in for banks to lend if ZIRP is maintained on the short end and the Fed tapers out of the QE bond buying business on the long end. Banks have indeed been lending. An end to ZIRP out in 2015, per Yellen's answer above, starts a clock ticking on a constriction of this carry trade racket, theoretically at least. All she did after all was wrestle with the English language ("So I , you know, this is the kind of term it’s hard to define") a little and give an answer (sort of).
But the 2009 to 2014 portion of the chart above is a distortion, no matter how you slice it. Normally, the S&P 500 runs positively with elevated or rising T Bill yields as it seems to test the will of policy makers every step of the way. This is the oldest contrarian play in the book; everybody fears rising interest rates, bears think it’s in the bag and yet the bull continues.
But this time the seed corn has already been used. I would argue that ZIRP should have been withdrawn long ago, let alone the vague "hard to define" timeline put out by the Fed Chief yesterday. The fact that ZIRP was not ended back in oh, 2010 or 2011, when inflation began to get out of control, was telling. What have they been afraid of? They say they want more 'jobs', less unemployment and more vibrant economic activity.
But you do not use something as powerful and potentially damaging as ZIRP for years on end unless there is something else going on.
This post has outgrown its original scope and so it will be concluded now.
Bottom Line
The conclusion is that it does not matter what Janet Yellen last week, the market is going to balance the sheet sooner or later. That balancing will either come through accelerating inflationary pressures already seeded into the system as the Fed is compelled to raise interest rates or it will come in the form of a deflationary clearing of distortions as inflated asset prices come back in line. The problem is, using the T Bill rate as a proxy, that line has been crawling along the floor for 5+ years now.
Financial markets promise to be very interesting during Ms. Yellen's first year at the helm. Let’s keep our preconceptions and biases under control and gauge what is actually happening every step of the way.
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