Three Times Yellen Wasn't Dovish

3 Times Yellen Wasn’t that Dovish in Her HFSC Testimony, July 13, 2017

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Markets interpreted Fed Chair Yellen’s comments to theHouse Financial Services Committee (HFSC) on Wednesday as dovish, and stocks rallied. However, I think that interpretation is more based on the markets’ perma-dovish expectation, and not the reality of her actual comments.

Broadly, the market confirmed that opinion, as the dollar was higher following her remarks. And though bond yields and banks did decline, the respective drops weren’t bad, especially considering the recent run up in yields and bank stocks. If Yellen was really dovish I would have expected the 10-year Treasury yield to fall sharply. Instead, it just drifted lower.

As I saw it, Yellen was broadly neutral, and most importantly, didn’t do anything to alter the expectation that the Fed will reduce the balance sheet in September and hike rates in December. To prove that point, I want to review the three lines of text the media focused on to spin Yellen’s testimony as dovish, and note they didn’t really change anything from a policy outlook standpoint.

Line 1: “Roughly equal odds that the U.S. economy’s performance will be somewhat stronger or somewhat less strong than we currently project.” I suppose that is less optimistic than if she said, “I think risks to the economic forecast are skewed higher.” But just because she didn’t say that doesn’t mean it’s a dovish statement.

More to the point, Yellen wouldn’t imply risks are skewed higher because 1) It’s probably not true (data hasn’t been great so far in 2017) and 2) She knows she’d spike yields. Additionally, to focus on that one statement is a bit of cherry picking, as Yellen made multiple positive mentions about the acceleration of economic growth.

Line 2: “Rates Won’t Have to Rise Much Further To Get to Neutral.” First, that’s nothing new. We know the Fed’s “neutral” interest rate level is very low (likely below 3%). Second, she continued by saying the “neutral” rate will rise over time as the economy gets better. So, as the neutral rate rises, so too will interest rates. Again, nothing new, and not dovish on its face.

Line 3: “There is—for example, uncertainty about when—and how much—inflation responds to tightening resource utilization.” First, tightening resource utilization is Fed speak for a tight jobs market. So, “responds to tightening resource utilization” is just the idea that rising wages (which are the result of a tightening labor market) causes broad-based inflation. Translation, Yellen said, “I don’t know when low unemployment will cause inflation, or how high inflation will get.”

Importantly, Yellen admitted we didn’t know “when” or “how much” inflation would rise given low unemployment, but she didn’t imply we don’t know “if.” Point being, her comments imply it will happen, it’s just un-clear when or how big it will be. Again, nothing new… and not dovish.

Bottom Line

Broadly, investors also focused on Yellen’s repeated mention of low inflation, which makes me think Friday’s CPI report could be soft, but to extrapolate out her comments as a dovish shift is too aggressive at this point.