What Yellen Didn’t Tell Congress And Why It Matters

What Yellen Didn’t Tell Congress And Why It Matters

ALISTER BULL, REUTERS NOV. 17, 2013, 8:05 AM 1,195 3

WASHINGTON (Reuters) – The most revealing thing about Janet Yellen’s widely praised Senate confirmation hearing performance last week might not have been what she said, but what she didn’t say – and how she didn’t say it. President Barack Obama’s nominee to be the next chair of the Federal Reserve smiled and nodded her way through a two-hour hearing on Thursday without giving the Senate Banking Committee any real clues as to how she views near-term monetary policy choices.She made plain that she thought it important to maintain aggressive efforts to spur U.S. economic growth and hiring. But her comments went no further than last month’s statement from the Fed’s policy-setting committee.

Senators asked her how long the central bank could keep buying bonds, and seemed satisfied with her mild observation that purchases could not go on forever. She provided no clues to whether she leans toward reducing them next month, or next year.

Economists had not expected her to intentionally front-run decisions yet to be made by the Fed’s policy-setting committee. For one thing, current Fed chief Ben Bernanke doesn’t step down until January 31. Yellen is expected to comfortably secure confirmation by the full Senate to replace him.

But successfully parrying questions before Congress without accidentally hinting on future policy was seen as an important first success for the 67-year-old former professor.

“She understood how to give an answer that was at least somewhat responsive to the question, without betraying any new information. It was an impressive performance,” said Stephen Oliner, a former senior Fed economist.

A second thing she didn’t say anything about was her view on strengthening the Fed’s forward guidance on when it might eventually raise interest rates.

Here she owes a big assist to the senators. No one asked about it even though speculation is rife that the Fed will soon decide to keep rates near zero at least until the jobless rate drops to 6.0 percent. Its current threshold is 6.5 percent.

Still, Yellen’s performance on other issues left little doubt that if she had been asked, she would have offered an even-handed discussion on the economic literature around the issue, with scant information on where she stood.

That was how she dealt with the query from Virginia Senator Mark Warner on lowering the interest the Fed pays on the excess reserves it holds for banks, which some officials think would be a way to give the economy a bit more stimulus.

Yellen explained the pros and cons, reminded lawmakers that reducing IOER, as it is called, could be problematic for the money market mutual fund industry, and left them none the wiser.

YELLEN FED

Keeping calm under pressure is an important quality for a successful central banker.

Fed watchers reckoned that it took Bernanke a year to really settle into the role, and recall the tell-tale quaver in his voice that betrayed the strain of being grilled by lawmakers.

To be sure, Yellen got far kinder treatment than Bernanke often received. Perhaps that was because the Fed’s Republican critics did not want to be seen baiting the first woman nominated to lead the central bank. Or perhaps they felt it would draw attention away from Obama’s health care woes.

But there was also interest in whether her reticence on shedding light on future policy might reflect a desire to avoid building expectations, which her colleagues at the Fed would subsequently have to either validate or ignore.

In essence, will the Yellen Fed be more like the Bernanke Fed or the Fed under Alan Greenspan? Greenspan was much more likely to offer clues on where he wanted to lead policy.

“Greenspan would give a little wink and nod and then the committee would have to go along after the fact,” said Michael Feroli, an economist at JPMorgan in New York.

“It is a probably good thing for the committee overall that she can sit in front of Congress and answer questions in a way that does not make the committee feel like their next move has to deliver on expectations set by what the chairman had already said.”

Stocks not near a bubble? Hold on there Janet Yellen

By Stephen Gandel, senior editor November 15, 2013: 12:04 PM ET

In the Fed’s mirror, a stock market bubble is appearing farther away than it may actually be.

Fortune — At Thursday’s confirmation hearing for Janet Yellen, the nominee to be the next Federal Reserve chairman was asked whether she thought there was a bubble in the stock market.

Yellen gave a pretty clear answer: No.

“Stock prices have risen pretty robustly,” Yellen said. “But I think that if you look at traditional valuation measures, you would not see stock prices in territory that suggests bubble-like conditions.”

Perhaps Yellen should have been even more bullish.

There are a number of ways to judge whether stocks are overvalued or undervalued. But the one most associated with the Fed — it’s nicknamed the Fed model — is to compare the stock market’s earnings yield, which is earnings/price or the inverse of the popular price-to-earnings multiple, to the interest rate on 10-year Treasuries.

The stocks in the S&P 500 (SPX) are expected to earn a collective $119.19 a share for 2013. Divide that by the S&P 500’s recent 1792, and you get an earnings yield, essentially how much the average stock is expected to return in income a year, of 6.8%.

The idea is that if you can get the same expected return from bonds, which are generally considered lower risk, buying stocks makes little sense. As bond yield approach stock yields, sell. On the flip side, when stocks yield more than bonds, buy.

The Fed has never officially blessed the model. But Greenspan referred to it regularly, and Yellen’s comments on Thursday suggest she looks at bond yields when valuing stocks as well.

The rate on 10-year government bonds is 2.7%. That means stocks are not only cheap, they’re a screaming bargain.

Critics would contend that the Fed model is meaningless right now. The Fed has been artificially driving down interest rates. That’s what’s making stocks look cheap.

But even before QE, some strategists thought the Fed model was flawed. Stocks and U.S. government bonds have different levels of risk. So back in the 1980s a number of prominent strategists contended that what you really needed to do was compare the earnings yield of the market to the expected interest rate on AAA-rated corporate bonds. Best guess for that is 4.9%, according to Randell Moore at Blue Chip Economic Indicators, which polls economists. So by that measure stocks are still cheap, but not by nearly as much.

Back in the ’80s, though, lots of U.S. companies were rated AAA. Few are today. The most common rating for U.S. corporate bonds is BBB+, one notch above junk. The expected yield on those bonds is 5.9%. Use that yield, and we’re not that far away from where the Fed model starts flashing sell.

We might get there pretty soon. When the Fed slows its bond buying, which most people expect will happen by the middle of next year, interest rates on all bonds are likely to go up, not just Treasuries. And corporate bond yields don’t have to move up much before stocks go from looking cheap, to rather expensive. Bubble territory is not as far away as it looks.