Janet Yellen, the newly installed head of the Federal Reserve, will make her first appearance before Congress as head of the central bank on Tuesday. Markets will listen to her comments for clues on the U.S. central bank's economic outlook and signals for any change in the Fed's monetary policy.
Yellen is scheduled to deliver her semi-annual Humphrey-Hawkins testimony before the Republican-controlled House Financial Services Committee on Tuesday. Her prepared testimony will be released at 8:30 a.m. EST, although the hearing does not begin until 10 a.m.
On Tuesday, the prepared testimony will be posted here. Also, watch the hearing live on C-Span. She will testify to the Democrat-controlled Senate Banking Committee on Thursday. On both occasions, she will read a prepared statement and then answer lawmakers’ questions.
Yellen, 67, became the first woman to lead the Fed on Feb. 1, succeeding Ben Bernanke. Yellen was previously the Fed's vice chair.
Yellen’s Primary Message This Week
Economists expect her written testimony on the economy to hue fairly close to the content of the December and January Federal Open Market Committee statements and December minutes, which laid the groundwork for the decision to taper asset purchases.
In particular, Bank of America Merrill Lynch’s Ethan Harris looks for Yellen to sound cautiously optimistic on the U.S. outlook, while noting the ongoing recovery warrants continued Fed accommodation.
Yellen will likely indicate that, provided Fed officials’ economic projections are realized, the FOMC remains on track to taper by a modest $10 billion per meeting. At the same time, she will probably reiterate that the Fed does not expect to hike rates until well after a full recovery is established.
“We expect her to be strongly supportive of forward guidance, but not provide many specifics beyond what has already been communicated in recent minutes, namely that the FOMC is moving in the direction of more qualitative guidance,” Harris said.
Steve Blitz, chief economist at ITG, laid out a handful of questions he said Yellen might get from lawmakers this week.
Question for Yellen: “Are you concerned that in pulling back QE, you are creating volatility in the emerging markets? Also, we’ve seen that the equity market had a very bad January. Is this evidence to you that the Fed has created a lot of volatility and extortion to the market?”
“It’ll probably be the third or fourth guy that asks this question about the emerging markets,” Blitz said. “I think her response to that is simply that they are the Fed for the U.S., not the world. Other nations have to manage their currencies and we have to do what’s best for the U.S.”
According to Blitz, Yellen’s response to the second part of the question is going to be along the lines of “We believe that we can’t be responsive to every zig and zag in the equity market. We do indeed believe that one of the reasons we are reducing the size of QE now is because we feel like we’ve gotten the most we can get out of it in terms of the impact to growth, and QE is distorting the market, so that’s why we are tapering.”
The Fed has trimmed its asset purchases twice since December, citing a pickup in the economy and job market. Assuming the economic outlook does not change drastically, Fed policymakers will reduce the bond buying, which now totals $65 billion a month, by a similar amount at each Fed meeting and halt it by the end of 2014.
Question for Yellen: “Will the Fed begin to increase short-term interest rates when the unemployment rate drops below the 6.5 percent threshold? If not, what metrics are the Fed looking at?”
According to Blitz, the Republicans will probably use this question to cite the latest report published by the Congressional Budget Office and make the point that the Affordable Care Act is hurting job growth.
The CBO report states that the Affordable Care Act could lead to a reduction in the number of full-time American workers by as many as 2 million.
Republicans might also make the point that the unemployment rate isn’t really as low as it seems because more and more people have stopped looking for jobs and have dropped out of the labor force.
The jobless rate ticked down to 6.6 percent in January but the overall drop in the labor force participation rate during the recovery from the recession shows the measure has lost much of its usefulness as an indicator of economic health.
Calculating jobless rate using the “U-6” figure, which includes the unemployed, the underemployed and the discouraged, the real unemployment rate is really 12.7 percent instead of 6.6 percent.
Blitz thinks Yellen will say: “Yes, this is the reason why we are not running a mechanical policy, where if the unemployment drops to a certain level, we are going to automatically start raising rates, and there is a lot more nuance to these numbers than the basic reports would indicate.”
“She’ll make this point in her testimony that they are looking at a lot of different things and they are not going to be mechanical in their approach,” Blitz added.
â€” Jim Rickards (@JamesGRickards) February 7, 2014
Question for Yellen: “More than a quarter of the loans extended last year to middle-market U.S. companies -- the backbone of corporate America -- were issued by shadow banks that fall outside the realm of traditional finance. Your regulations and changes are dissuading banks from lending to middle-market firms. Yet, one of former Fed Chair Ben Bernanke’s points regarding why the economic contraction was as great as it was, was that so much of the financing of the U.S. economy sat outside of the banking system and hence was not under the regulatory control of the Fed. So what are we doing here? Are we setting up for a similar problem going forward if an increasing volume of the financing of middle-market firms is coming now from outside of the banking system?”
“I don’t know if anyone is going to ask this question, but this is a question that’s worth answering. I hope they’ll bring up,” Blitz said.
Banks issued 73 percent of middle-market loans in 2013, according to data from Thomson Reuters, down from 81 percent in 2012. It is the lowest proportion since the 62 percent share reported in 2006, at the height of the credit bubble.
U.S. banking regulators including the Fed, Office of the Comptroller of the Currency and Federal Deposit Insurance Corp sent an advisory in March outlining target underwriting criteria, including leverage ratios and a timeline for debt repayment.
As banks scaled back in lending to the middle-market -- or businesses with less than $500 million in annual revenues -- non-bank lenders (such as hedge funds) have stepped up to fill the gap.
“The non-bank guys that are lending say they are better situated to take that risk and to get that return because they are not taking deposits guaranteed by the Federal government,” Blitz said. However, the growth of shadow banks is also prompting concerns.