Will Janet Yellen's Testimony Confirm Market Expectations?

When Fed Chair Janet Yellen testifies before Congress starting today, she is likely to say that a June hike is still on the table, though not a done deal. To better understand the gulf between Federal Reserve expectations and market expectations, I scanned the Tim Duy believes that there are two key conditions that need to be met before the Fed starts to raise rates. Most importantly, they need to see either rising core inflation, rising expectations of wage inflation, or accelerating wage inflation (emphasis added):

To get a reasonably sized consensus to support a rate hike, two conditions need to be met. One is sufficient progress toward full-employment with the expectation of further progress. I think that condition has already been met. The second condition is confidence that inflation will indeed trend toward target. That condition has not been met. To meet that condition requires at least one of the following sub-conditions: Rising core-inflation, rising market-based measures of inflation compensation, or accelerating wage growth. If any were to occur before June, I suspect it would be the accelerating wage growth.

Finally, the Fed recognized that it was boxed in with regard to the "patient" language that had been interpreted by the market as two FOMC meetings and doing so would spook the markets:

Participants discussed the communications challenges associated with signaling, when it becomes appropriate to do so, that policy normalization is likely to begin relatively soon while remaining clear that the Committee's actions would depend on incoming data. Many participants regarded dropping the "patient" language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions. Participants discussed some possible communications by which they might further underscore the data dependency of their decision regarding when to tighten the stance of monetary policy. A number of participants noted that while forward guidance had been a very useful tool under the extraordinary conditions of recent years, as the start of normalization approaches, there would be limits to the specificity that the Committee could provide about its timing. Looking ahead, some participants highlighted the potential benefits of streamlining the Committee's postmeeting statement once normalization has begun. More broadly, it was suggested that the Committee should communicate clearly that policy decisions will be data dependent, and that unanticipated economic developments could therefore warrant a path of the federal funds rate different from that currently expected by investors or policymakers.

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In summary, a careful read of the FOMC minutes by distinguishing between the phrase "many participants", "some participants" and "a number of participants" can give us a better understanding of how the consensus at the Fed is developing. Indeed, the language of "many participants" is defining market expectations of Federal Reserve monetary policy.

We will have to watch the tone of Janet Yellen's testimony to see how her testimony aligns with the views of "many participants".

Disclosure: Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

None of the information or opinions expressed in this blog constitutes a solicitation for the purchase or sale of any security or other instrument. Nothing in this article constitutes investment advice and any recommendations that may be contained herein have not been based upon a consideration of the investment objectives, financial situation or particular needs of any specific recipient. Any purchase or sale activity in any securities or other instrument should be based upon your own analysis and conclusions. Past performance is not indicative of future results. Either Qwest or Mr. Hui may hold or control long or short positions in the securities or instruments mentioned.

Written By: Cam Hui