Fed’s Yellen Turns Hawkish – Rate Hike As Early As March

Federal Reserve Chair Janet Yellen appeared before Congress on Tuesday for the first day of her semiannual testimony on monetary policy. In a surprise to many, Yellen gave the markets a wake-up call — that the Fed is serious about raising interest rates three times this year, and possibly as early as the next Fed Open Market Committee (FOMC) meeting on March 14-15.

In her prepared speech to the Senate Banking Committee, Yellen said the central bank will continue to raise interest rates slowly, and warned that the next rate hike could come at any of the upcoming policy meetings. She cautioned:

 “As I noted on previous occasions, waiting too long to remove accommodation [rate hike] would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.”

The Fed has indicated that there could be three rate increases in 2017, which would lift interest rates further away from the ultra-low floor that the financial crisis necessitated.

Based on the dovish policy statement following the January 31-February 1 meeting of the FOMC, most Fed-watchers assumed that a rate hike at the March meeting was off the table. Not anymore after her upbeat economic comments on Tuesday and Wednesday:

“I can’t tell you exactly which meeting it would be. I would say every meeting would be live.”

That was Yellen’s subtle way of telling the markets that the next rate hike could come at any upcoming FOMC meetings, including the March meeting.

Before her Senate comments on Tuesday, Fed Funds futures showed only a 16% chance of a rate hike in March; after her comments, those odds went up to 23%. May odds jumped from 38% to 50%, and June odds rose to near 100%.

The US dollar rose after Yellen’s hawkish comments, hitting a high not reached since January 20. Stocks also rallied despite the warning of upcoming rate hikes, with new highs on the Dow and S&P 500.

Yellen was also asked about the process of shrinking the central bank’s gargantuan balance sheet, which ballooned to $4.5 trillion during the years of “quantitative easing” and bond-buying programs after the financial crisis.

The Fed has discussed winding down the balance sheet, which is made up of both Treasuries and mortgage-backed securities. In her comments, she said the future makeup of the balance sheet would be mostly Treasuries, and the Fed would wait to unwind them until after it has raised interest rates to more normal levels.

Yellen also said the Fed would allow the mortgages to roll off when they mature, and would not sell the securities before such time.

Trump Could Get to Fill Five Open Seats on Fed Board

Last week, Daniel Tarullo, chairman of the Fed’s Committee on Supervision and Regulation responsible for regulating Wall Street banks, resigned. The obvious signal from Mr. Tarullo’s exit is that a big shift in financial regulation is indeed imminent.

When asked about her own tenure at the Fed, Yellen replied, “I do intend to complete my term as Chair.” Her term is up in February 2018. The current Fed Board of Governors already has two vacant seats, and Tarullo’s resignation will make it three open seats, out of seven total, for President Trump to fill this year.

When Yellen’s term is up next February, she can either retire or she could stay on the Board as one of the Governors. Most Fed-watchers expect her to retire, thus leaving Trump a fourth Fed Board seat to fill.

It is also not unusual for the Fed Vice-Chairman to retire at the same time the Chairman retires. The current Fed Vice Chairman is Stanley Fisher who will be 74 later this year. If he retires when Yellen does, that would make a total of five open seats (out of seven total) for President Trump to fill. And this could all happen in his first two years in office!

This is unprecedented. While President Bush (43) had 9 Fed Board appointments, President Clinton had 6 and President Reagan had 8, those were over eight years in office.

It wasn’t supposed to happen this way. Fed governors have staggered 14-year terms precisely because the designers wanted to ensure that no one president had too much influence.

Their mistake was in assuming people would stick around that long. They don’t, as a rule. Other career opportunities come up and Board members resign early, leaving openings for presidents to fill. Very rarely does anyone complete a full term. Alan Greenspan was the last one to do so.

For better or worse, President Trump can have a huge impact on the Fed.

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