‘Yellen Effect’ Limited So Far

Terry Flanagan

Janet Yellen’s first six weeks as Chair of the Federal Reserve had a limited effect on the markets, as there was essentially full continuity of the policies of her predecessor, Ben Bernanke. Indeed, the ‘Yellen Effect’ was mostly a fall-2013 function of her gaining the upper hand and then winning out over Larry Summers, whose views on monetary policy were perceived as more hawk-like than Yellen’s, in the horse race to succeed Bernanke.

There was some market turbulence on March 19, after the first Federal Open Market Committee meeting led by Chair Yellen. As expected, the Fed left its benchmark interest rate at zero and maintained the pace of the ‘taper’, reducing its quantitative easing program by $10 billion per month. But there was a change in that the Fed said it will look at a range of data in considering when to start ratcheting up rates, scrapping its plan of tying borrowing rates specifically to getting the unemployment rate down to 6.5%.

Yield on the benchmark 10-year U.S. Treasury spiked 10 basis points to 2.78% after the FOMC meeting, and the release of Fed officials’ projections that rates may be raised sooner than some market participants may be expecting.

The afternoon saw possibly the most volatile bond trading period since Yellen was sworn in on Monday, Feb. 3. The 10-year note closed at 2.68% on March 18, little changed from the level on Jan. 31, the business day before Yellen was sworn in.

For her part, Yellen acknowledged the need to keep rates low. “We’ve lived through a devastating financial crisis that has taken an exceptional toll on the economy in many ways,” she said. 

“Ms. Yellen has experience defining policy and thus far, her prescriptive approach to reducing quantitative easing is playing well,” Anthony Perrotta, chief executive of Cornerstone Resources, told Markets Media before the announcement. “How she manages expectations moving forward will have a huge impact on whether or not we see the ‘Great Asset Rotation’ some portend.”

Most market participants and observers expect rates to rise from still-low levels as economic growth gains traction and the Fed and other central banks rein in easy-money policies. In a plugged-in world where market participants parse every word from the Fed for clues on policy direction, the onus is on Yellen to communicate clearly and limit surprises to avoid bond-market sell-offs and possible rotations into equities.

The benign ‘Yellen effect’ was evidenced after Sept. 15, 2013, the day Summers withdrew his name from consideration for the Fed job. Yield on the 10-year Treasury slid from 2.87% on Monday, Sept. 16, to 2.48% on Oct. 23.

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