Janet Yellen’s Dovish Swan Song

Last week Janet Yellen made her final scheduled semiannual monetary report to Congress and the Senate. Her position as chair expires on February 3, 2018, and President Donald Trump has a team looking for a possible replacement. We will have to wait and see who will next lead the Federal Reserve.

Janet Yellen’s testimony was widely considered to be dovish, and the markets ended the day with equity and bond prices higher. In light of persistently weaker than expected inflation data, Yellen left the door open for a more gradual rise in interest rates than what was previously anticipated. As she said in her prepared remarks, “With inflation continuing to run below the Committee's 2 percent longer-run objective, the FOMC indicated in its June statement that it intends to carefully monitor actual and expected progress toward our symmetric inflation goal…Of course, considerable uncertainty always attends the economic outlook. There is, for example, uncertainty about when—and how much—inflation will respond to tightening resource utilization.” 

Yellen gave further lift to the markets by reiterating that any reduction in the Federal Reserve’s balance sheet will be gradual, and there is no firm date for when this tapering will begin. However, expectations are that tapering will begin in 2017. All this dovishness seems strange to us. We were so accustomed in recent years to the Fed playing the hawk among worldwide central bankers. Yet now Yellen appears more dovish while there is an increasingly hawkish tone from Europe, the U.K. and Canada.

The Federal Reserve’s small change in policy is interesting, but in reality, the impact of recent news is not as important as the fundamentals: central banks around the world remain highly accommodating, worldwide GDP growth is positive and looking up in many areas, and inflation expectations are subdued. All these fundamentals create an attractive environment for fixed income investors, regardless of the dovish tone of Yellen’s swan song.

Source: The Federal Reserve, Bloomberg, The Financial Times