PMC Weekly Review - February 27, 2015

A Macro View – The Fed still “patient” and “lower for longer”

Fed Chairwoman Janet Yellen offered few surprises in her semi-annual testimony before Congress this week. Testifying before the Senate Finance Committee on Tuesday this week, Chairwoman Yellen continued to use the word “patient” in describing the FOMC’s approach to “normalizing” monetary policy, including raising short term interest rates. She also reiterated her stance on waiting for the appropriate data that would convince the Federal Open Market Committee (FOMC) inflation would be above 2% for the intermediate term. Ms. Yellen was relatively clear these conditions had not been met as “the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the fed funds rate for at least the next couple of FOMC meetings1.” These comments pushed 10-year Treasury yields down 13 basis points on the day and back below 2% for the first time in nearly two weeks. Thursday’s Consumer Price Index (CPI) report, with headline inflation at -0.1% for the trailing 12 months ended January and core CPI at 1.6% over that same period, likely did little to push the Committee toward acting any time soon. The global rate environment is expected to impact the Fed’s timing as well and recent data is even less compelling there. Germany sold 5-year Bunds at auction this week with an average yield of -0.08% and Italian, Spanish and U.K. 10-Year rates all set post-financial crisis lows in the last month.

Also included in her testimony was the reiteration that even after the economy strengthened enough to raise the fed funds rate, the lingering effects of the global financial crisis may make it necessary for the fed funds rate to “run temporarily below its normal longer-run level".1 This “lower for longer” language has been consistently part of Fed comments for some time now and points to the potential for fed funds to remain below 2% for several years. Given the massive amount of liquidity that has been added to the domestic economy over the last five years, let alone the global economy, the Fed will need to begin removing at least some of that liquidity before any rate hikes will have their desired effect. Secondarily, Chairwoman Yellen must be aware of the enormous damage to her and the Fed’s credibility with the markets if the rate hikes have to be reversed in short order due to economic weakness. This alone should keep the Fed on the sidelines as long as possible.

U.S. Markets continued their slow march forward, with U.S. small cap and growth stocks leading the way for the week. Value stocks of all market caps hovered near the flat line. Despite the lackluster returns for the week, all of the U.S. equity indexes continue to show significant strength for the month with returns ranging from 4.7% to 7.8%. As noted in this space last week earnings season has been very strong with nearly three quarters of companies in the S&P 500 beating their consensus earnings expectations. However, of the 74 companies announcing revisions to Q1 2015 earnings expectations, 85% of them revised expectations downward. Despite the drop in Treasury yields during the week, the investment grade fixed income indexes remain in solidly negative territory across the board for February, but have not given all of January’s gains back yet. U.S. corporate high yield spreads have narrowed by more than 70 basis points this month, generating very good returns for both the month and the year-to-date. The only exception remains the distressed credit market (below CCC) which is down more than 2% for the year. Finally, the continued strength of the dollar leaves the global fixed income markets in negative territory for the most part, though hedging out the dollar impact places most of them on par with the U.S. Aggregate Index.

1Quotes Source: Chair Janet Yellen, "Semi-Annual Monetary Report to Congress", February 24, 2015

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