Federal Reserve Chair Janet Yellen endured today what was easily the most brutal bi-annual Humphrey Hawkins testimony yet on Capitol Hill. The three hours before the House Financial Services Committee was marked by relentlessly sharply edged, populist-tinged questioning that took an almost inquisition tone at times.
In between the aggressive criticism of the Fed’s 13-3 bail-out powers, complaints that no bankers went to jail in the 2008 crisis, attacks on the “subsidies” to banks in paying interest on the reserves, an especially bitter assault on the Fed’s handling of the “Medley Affair,” and harsh demands to move to rules-based policy that opened the hearing, three key takeaways stood out to us:
*** On negative rates: Market interest in the prospects for negative interest rates has been at near-obsessive levels in recent days, but we seriously doubt the Fed is weighing that as a near term policy option. In response to several questions on the issue, everything Chair Yellen said in her carefully worded responses seemed to reflect just that, that while there is nothing stopping the Fed from turning to negative rates as a policy tool in the very unlikely event they would be seriously considered, negative rates would not be a preferred tool, there are concerns over the impact on the money markets and payment “plumbing” issues, and the Fed is still looking into the question of its legal authority. ***
*** On the rate outlook: Chair Yellen carefully protected the Federal Open Market Committee’s March meeting rate options, but on balance, a dovish lean was unmistakable in the tone and thrust of her remarks, and we do continue to think the odds are rather low for a rate hike in March, albeit as a pause rather than a policy reversal to rate cuts (see SGH 1/27/16, “Fed: A Dovish Lean”). She repeated in almost Marco Rubio robotic terms that “monetary policy is not on a preset course” and cautioned against “a premature conclusion” on the outlook and rates. She did her best to balance the assertion that the Fed sees no recession on the horizon and no reason the next rate move won’t be up rather than down, but she went at length in noting the downside risks in the market turmoil and the developments abroad, and that financial conditions have indeed become less supportive to growth. ***
*** The policy tool option kit: A Capitol Hill testimony is a less than ideal forum to lay out the Fed’s policy options if the economy should turn south, but the question did surprisingly come up, even if it got so muddled and rushed it allowed the Chair from getting too specific. But beyond the testimony today, our sense is that an extend pause and dovish language would be the policy option of first resort to counter an unlikely downturn, followed by a revived “Twist” on top of the reinvestment policy, as we noted recently (SGH 2/4/16, “Fed: Tactical Adjustments, Same Strategy”). Another dollop of open ended QE, negative rates, or a higher inflation target are all further down the list and would only be considered if a deepening recession truly threatened. ***
Chair Yellen is only half way through her run of the gauntlet on Capitol Hill, appearing before the Senate Banking Committee tomorrow. Chairman Richard Shelby may not be as harsh in his questions as his more ideologically-driven House counterpart, Jeb Hensarling. But the Alabama Senator is still likely to drill hard on the Fed’s regulatory powers, and there is near certainty of a repeat of critical questions over the subsidies being handed out to the big banks in paying rising interest on excess reserves in trying to raise interest rates.
In other words, the populist anger will no doubt come through clear enough again tomorrow – a defining marker on how the Fed is likely to be playing defense throughout an already volatile election year.