Morning Report – Bonds sell off on strong ISM report 12/3/13

Vital Statistics:

Last Change Percent
S&P Futures 1794.3 -5.4 -0.30%
Eurostoxx Index 3033.9 -43.3 -1.41%
Oil (WTI) 93.81 0.0 -0.01%
LIBOR 0.241 0.002 1.03%
US Dollar Index (DXY) 80.62 -0.302 -0.37%
10 Year Govt Bond Yield 2.77% -0.03%
Current Coupon Ginnie Mae TBA 105 0.1
Current Coupon Fannie Mae TBA 104.1 0.1
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.43
Weaker overseas markets mean US stocks are soggy this morning. Bonds and MBS are rallying small. Later on this morning, we will get the ISM New York and IBD / TIPP economic optimism.
Corelogic reported that home prices were up 12.5% year over year and up .2% in October. Home prices remain 17.3% below their April 2006 peak. The .2% month-over-month gain shows that real estate price growth is moderating, which was more or less to be expected. Almost half the states in the US are within 10% of their respective historical price peaks.
Yesterday’s bond sell-off was triggered by a better-than-expected ISM report, which showed that manufacturing is improving in the US and is approaching two year highs. If you look at the historical relationship between the ISM and GDP growth, the November number of 57.3 corresponds to a 4.7% increase in real GDP. The 2013 average corresponds to a 3.6% increase. Manufacturing isn’t as large of a component of the US economy as it used to be, but it does show that at least one major sector in the US is picking up steam.
The other sector that really matters is housing / construction, and there we still have relatively moribund numbers, although they are steadily building back off the lows. Construction spending increased .8% month over month in October after falling .3% in September. We still have yet to get housing starts data since August, but building permits topped a 1 million pace in October. Part of the reason why this recovery has been so weak is that housing is usually the first industry to rebound after a recession and we are still at very depressed levels historically. Part of that has to do with the excesses of the bubble and low household formation numbers due to the lousy job market. The excesses of the bubble are more or less reversed and if anything, we have a deficit. The low household formation numbers have been driven by a lousy job market, not fertility rates 25 years ago, and therefore represents pent-up demand. This state of affairs cannot last (and won’t).
So maybe the holidays won’t be so bad after all. It looks like Cyber Monday sales were record-breaking after Black Friday sales were disappointing. Even still, it looks like the retailers are being highly promotional, which doesn’t exactly speak to a healthy consumer environment. Many noted that using a deal as “bait” fell flat on its face as customers got in line to purchase one specific item, and bought it without buying anything else. Back-to-School was lousy, so it is hard to get over-optimistic about the holiday shopping season. One other thing to note – we can now look forward to the FAA regulating internet sales.

Morning Report – Black Friday disappoints 12/2/13

Vital Statistics:

Last Change Percent
S&P Futures 1804.7 0.6 0.03%
Eurostoxx Index 3080.2 -6.4 -0.21%
Oil (WTI) 93.09 0.4 0.40%
LIBOR 0.239 0.000 -0.10%
US Dollar Index (DXY) 80.9 0.220 0.27%
10 Year Govt Bond Yield 2.78% 0.03%
Current Coupon Ginnie Mae TBA 105.3 0.0
Current Coupon Fannie Mae TBA 104.1 -0.2
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.38
Markets are flattish as traders return from a long weekend. Bonds and MBS are down. At 10:00 we will get the ISM manufacturing report and construction spending.
There is a lot of data this week, starting with the ISM report today, GDP on Thursday, and the all-important jobs report on Friday. Given the October surprise and the fact that the bar is set pretty low for Friday’s report (180k jobs / 7.2% unemployment) bonds could be vulnerable as any upside surprise will re-ignite December taper talk.
Black Friday was disappointing according to the National Retail Federation, as retailers were highly promotional early into the holiday shopping season. We have seen Wal Mart and Target already cut profit forecasts for the year. On Thursday, we will get the comp store data dump from all the retailers as they report November same store sales. We might see some profit warnings as well. It is hard to see how the Fed sees growth accelerating into 2014 with a consumer that is still cautious.
The White House is saying that the healthcare.gov website is operating fine, therefore it made its self-imposed Dec 1 deadline. The Administration is hoping that this will mollify Democrats in red districts with cold feet about the whole thing. We’ll see if it actually “works for the vast majority of users” as HHS claims it does.

Morning Report – NAR forecasting home prices to moderate in 2014 11/27/13

Last Change Percent
S&P Futures 1805.0 3.0 0.17%
Eurostoxx Index 3084.1 21.5 0.70%
Oil (WTI) 92.22 -1.5 -1.56%
LIBOR 0.2376 0.001 0.42%
US Dollar Index (DXY) 80.67 0.059 0.07%
10 Year Govt Bond Yield 2.73% 0.02%
Current Coupon Ginnie Mae TBA 105.234 -0.2
Current Coupon Fannie Mae TBA 104.344 -0.2
RPX Composite Real Estate Index 200.67 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.33
Markets are higher this morning after a mixed bag of economic reports. Due to the Thanksgiving Day holiday, this morning included reports scheduled for tomorrow. Bonds and MBS are down small.
Initial Jobless Claims came in at 316k, the lowest level in 2 months. Durable Goods orders fell 2%, which was more or less in line with Street expectations. Consumer Confidence came in higher than expected. Chicago Purchasing Managers dropped, but not as much as expected. Finally leading economic indicators rose .2%. Bottom line: so much for the theory that the government shutdown affected the economy outside of the luxury car dealerships around Tyson’s Corner.
Mortgage Applications fell slightly as rates ticked up a couple of basis points. Surprisingly, refis rose while purchases fell.
FHFA decided not to change the conforming loan limits, which really isn’t much of a surprise. Incoming FHFA Chairman Mel Watt does not have an appetite for reducing the government’s footprint in the mortgage market. Whether that means anything for FNMA shareholders (and pref holders) is an open question. Ralph Nader (yes) is agitating in defense of shareholders.
Again, I think the under-appreciated story is that Mel Watt will in fact be the new FHFA Chairman. This means principal reductions on loans held by F&F, a probable extension (and loosening) of the HARP plan, and definitely more focus on low-income lending. Watt is a CRA guy to the bone. The reason why the MBA has supported his candidacy was because he would presumably usher in a wave of refis.
Pending Home Sales dropped .6%, according to the National Association of Realtors. This is unsurprising given the government shutdown and the inability of mortgage bankers to get tax returns out of the IRS. The NAR is warning that the new QM rules may depress sales in early 2014. They also forecast home price growth to slow from 11% in 2013 to 5% in 2014. It is an interesting dynamic with tight inventory on one hand, and decreasing affordability on the other. If the job market improves, especially for the Millenials, there will be a wave of pent-up demand that is going to enter the market. Household formation has been severely depressed over the past 6 years, not due to demographics, but due to a lousy economy. Homebuilders have underbuilt for ten years, and foreclosures remain tied up in the courts in the judicial states. And while affordability may have decreased, anyone with gray hair remembers the days when a 4.5% mortgage was considered unheard-of, something that your dad might have been able to get in the 1960s, but a relic of a bygone era.

Morning Report – Harry goes nuclear, Watt does that mean? 11/26/13

Vital Statistics:

Last Change Percent
S&P Futures 1802.7 0.3 0.02%
Eurostoxx Index 3068.0 -4.8 -0.16%
Oil (WTI) 94.1 0.0 0.01%
LIBOR 0.2366 0.001 0.32%
US Dollar Index (DXY) 80.865 -0.055 -0.07%
10 Year Govt Bond Yield 2.71% -0.01%
Current Coupon Ginnie Mae TBA 105.365 0.0
Current Coupon Fannie Mae TBA 104.477 0.1
RPX Composite Real Estate Index 200.67 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.34
Sorry I haven’t put one of these out in the last couple of days – been traveling for the holidays.
Markets are flattish on no major news. This week should be relatively dull, with no major economic reports. Bonds and MBS are flat as well.
We have had some economic data over the past couple of days. Pending Home Sales came in at -.6%, which is evidence the housing recovery may be slowing down a bit. That said, prices are still rising at a rapid clip, with the Case-Shiller index up 13.3% on a year-over-year basis and the FHFA House Price Index up 2% for the third quarter.
Building Permits came in at 974k, higher than the Street estimate. We didn’t get housing starts today due to the government shutdown.
One piece of news from last week – Harry Reid “went nuclear” and changed the rules regarding Presidential nominations. Now, nominees cannot be filibustered. Watt does that mean? It means Mel Watt will be the next FHFA Chairman. Mel Watt is basically a CRA guy, so expect a lot of fair-lending scrutiny. Also, he will do everything he can to expand HARP and HAMP. Watt does that mean for originators? Maybe one more refi wave.
Mel Watt wouldn’t take a position on the use of eminent domain to handle underwater mortgages, which is pretty much tacit approval of the strategy. Expect a lot of consumer friendly / investor unfriendly stuff to come down the pike. Principal mods are almost a given, although there will be push-back from investors. Not that the government is going to care about hurting hedge funds or mortgage REITs, but there are investors they do care about, namely pension funds. Pension funds have been begging the government not to do this, and this will certainly lead to interesting political dynamics.

Morning Report – Parsing the FOMC minutes 11/21/13

Vital Statistics:

Last Change Percent
S&P Futures 1783.8 4.1 0.23%
Eurostoxx Index 3050.5 3.2 0.10%
Oil (WTI) 94.25 0.4 0.43%
LIBOR 0.238 -0.001 -0.21%
US Dollar Index (DXY) 81.08 -0.035 -0.04%
10 Year Govt Bond Yield 2.81% 0.01%
Current Coupon Ginnie Mae TBA 105.3 -0.4
Current Coupon Fannie Mae TBA 104.3 -0.1
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.38
Markets are higher this morning on no real news. Bonds and MBS continue their post-FOMC minutes sell-off.
Initial Jobless Claims came in at 323k, lower than the 335k street forecast. Inflation at the wholesale level remains muted.
The bond market sold off on the FOMC minutes, as people who had been holding out hope that the September non-move meant QE4EVA were disabused of that notion. The Fed largely dismissed the effects of the government shutdown as “temporary and limited.” Given the October jobs report and October retail sales, they are correct – we just didn’t see any effect from the shutdown except for a temporary spike in the 1 month T-bill. They again repeated the view that the economy is strengthening, and if things play out as we expect, we should be tapering QE in the next few months.
Sometimes you have to parse the Fed’s characterization of things. On the Fed’s scale:
Economic Growth – “moderate”
Inflation – “modest”
Corporate Credit – “robust”
CAPEX – “tepid”
In other words, growth is just ok, inflation is too low, business investment is way too low, and the Fed is beginning to worry about bond investors reaching for yield. This means that QE’ days are numbered as the risks of an overheated credit market are becoming larger than the risk of a credit crunch. However, low interest rates are probably here to stay until business investment, inflation, and employment are closer to where the Fed wants to see things.
One thing to keep in mind is that the Fed’s footprint has been increasing in the MBS market as issuance drops. The end of the refi boom meant lower overall MBS issuance but the Fed has been been maintaining a constant $40 billion a month. As a percentage of total volume, their footprint has been increasing. You can see it in MBS spreads, which have tightened to Treasuries. While the market has been of the view that the Fed would taper Treasury purchases first, lest it derail the nascent housing recovery, an adjustment in MBS is probably in order. This could mean a double-whammy for mortgage rates – The benchmark (Treasuries) increases in rate, and the spread to Treasuries increases as well. Float at your own peril..
I find it ironic that the Fed worries about people conflating a reduction in QE with a tightening of monetary policy, yet at the same time refers to “fiscal headwinds.” Reality Check: fiscal policy is about as loose as it gets, unless you compare it to a completely artificial benchmark of the past 5 years. Post WWII, government spending averaged around 19% of GDP. We have averaged 24% over the past 5 years. We are still at 22%. 5 of the 7 largest postwar deficits as a percent of GDP have been in the past 5 years. Calling a slight reduction in government spending as a “fiscal headwind” makes as much sense as characterizing a reduction in asset purchases from 85 billion a month to 65 billion a month as “tightening monetary policy.” It is the dieting equivalent of having a diet coke with your triple whopper value meal.
As home prices rise, negative equity has continued to fall, according to Zillow. The percentage of homes with negative equity dropped to 21% in the third quarter from 23.8% in the previous quarter. Negative equity has been a big reason why existing home sales have been so depressed. Yesterday we saw an annualized pace of 5.12 million, which is slightly below average. IMO, there is pent-up demand that is being held back by negative equity. As that condition rights itself, we should see existing home sales numbers well in excess of historical averages. The mortgage bankers who do purchase activity well will reap the benefit.

Morning Report – Median House price increases 12.8% 11/20/13

Vital Statistics:

Last Change Percent
S&P Futures 1788.5 3.3 0.18%
Eurostoxx Index 3043.7 -5.5 -0.18%
Oil (WTI) 93.71 0.4 0.40%
LIBOR 0.238 -0.001 -0.42%
US Dollar Index (DXY) 80.64 -0.066 -0.08%
10 Year Govt Bond Yield 2.73% 0.02%
Current Coupon Ginnie Mae TBA 105.6 -0.1
Current Coupon Fannie Mae TBA 104.8 0.0
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.3
Markets are higher after retail sales came in a bit better than expected. Bonds and MBS are down small. Later on today, we will get the minutes from the October FOMC meeting. It will be interesting to see if the credibility argument is still being made.
Existing Home Sales dropped to an annualized pace of 5.12 million in October according to the National Association of Realtors. The median house price rose 12.8% from a year ago to $199.500. Days on market increased to 54 and months of supply increased to 5. Inventory on the West Coast is still tight.
Mortgage applications fell 2.3% during the holiday-shortened week. Purchases jumped 5.8%, while refis dropped 6.5%. Not sure what drove the jump in purchases. Refis as a percent of total number of loans fell to 64.3%.
Chart: MBA Purchase Index

The Consumer Price Index came in as expected, with a .1% decrease month-over-month and a 1% increase year over year. Ex food and energy, prices rose .2% month-over-month and 1.7% year-over-year. Certainly not enough of an increase to get the Fed worked up about inflation. If anything, they probably think it is too low.

Retail Sales came in at +.4% for October, which is yet another sign that the consumer (and the economy) basically yawned at the government shutdown. For all the sturm and drang out of guys like Mark Zandi saying the shutdown would lop 1.4% off of 4Q GDP growth, we have yet to see any tangible evidence it so far. Payroll was par for the post-recession course, retail sales were above average.

Housing-related expenditures make up about 17.6% of GDP, according to CoreLogic. This is up slightly from a year ago, but well below the peak of 20.6% in 2005. Part of the reason why this recovery has been so maddeningly tepid has been the absence of housing spending, particularly housing starts. Housing starts used to average around 1.5 million units a year from the sixties to the bubble years. Since then, we have been averaged under half of that. Since housing construction usually leads us out of a recovery, it absence has meant this slog of 1% – 2% GDP growth. Note that the homebuilders were noting mid teens increases in average selling prices amidst a drop in traffic. At some point, they are going to have to pump up the volume in order to meet achieve further growth. And that could be what we have been waiting for.

I went on Louis Amaya’s show yesterday and talked about the mortgage originators, servicers, and some of the REITs. I also discussed the origination business in general and trends going forward. The link is here.

Morning Report – 11/19/13 – Fedspeak

Vital Statistics:

Last Change Percent
S&P Futures 1787.7 -1.0 -0.06%
Eurostoxx Index 3059.2 -22.1 -0.72%
Oil (WTI) 92.83 -0.2 -0.21%
LIBOR 0.239 0.002 0.74%
US Dollar Index (DXY) 80.73 -0.098 -0.12%
10 Year Govt Bond Yield 2.69% 0.03%
Current Coupon Ginnie Mae TBA 106.1 0.0
Current Coupon Fannie Mae TBA 105 -0.1
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.33

Markets are lower this morning on no real news. The employment cost index rose .4% in the third quarter, lower than expected. Bonds and MBS are down small.

Yesterday we had some Fed-speak with Philly Fed Head Charles Plosser urging the Fed to stop playing “this bond buying game by ear” and to tell the markets how much the Fed intends to buy and then to stop once it gets to that level. Plosser also claimed that the recent low inflation numbers were transitory due to lower government spending on things like Medicare. Separately, New York Federal Reserve Chairman William Dudley said he is becoming more optimistic that 2014 and 2015 will be much stronger than 2013. He said the “fiscal drag” of the sequester is abating. Pet peeve – the Fed goes out of its way to say that reducing tapering is not “tightening,” yet refers to a tiny reduction in unprecedented postwar fiscal stimulus as “fiscal drag.” Even with the sequester, fiscal policy is still highly, highly accommodative and looks miserly only if you compare it to 2009 or 2010.
Good story out of Bloomberg on the pickle the Fed is in with respect to QE.  How to reduce tapering without increasing interest rates. The Fed would really, really like to avoid a repeat of last summer where the 10 year bond increased by 100 basis points. Yellen said in her testimony that the answer was better communication, however as everyone has acknowledged, we are in uncharted territory here. Separately, the Senate Banking Committee is scheduled to vote on Yellen Thursday, which will set the stage for a full Senate vote later this year.Tomorrow starts the big data dump for the week with a slew of economic reports. We will get the minutes from the October FOMC meeting, existing home sales, retail sales and the consumer price index.

Speaking of retail sales, the holiday shopping season is shaping up to be on the weak side. We have already seen two warnings out of Wal Mart this year, and now Best Buy is saying that promotional activity is going to hurt margins. I keep hearing anecdotal evidence that the retailers are getting promotional already, which is a bad sign ahead of Thanksgiving. On the other hand, the Despot reported better than expected 3rd quarter earnings as people are taking advantage of the increase in house prices to do some remodeling.

Remember the 2012 jobs report ahead of the election where Jack Welch tweeted “”Unbelievable jobs numbers…these Chicago guys will do anything…can’t debate so change numbers,” He was fired from Fortune over that. Well, it turns out that he may have been correct. Census may have been doing some monkey business with the report.

Small banks asked for some temporary relief from some of the new edicts coming out of CFPB and were given the Heisman. CFPB has said that they will take into account good faith efforts to comply with the rules, but as Rob Chrisman points out, the plaintiffs’ attorneys definitely will not.

Morning Report – Slowish week ahead 11/18/13

Vital Statistics:

 

  Last Change Percent
S&P Futures  1796.1 2.6 0.14%
Eurostoxx Index 3082.4 27.9 0.91%
Oil (WTI) 93.46 -0.4 -0.40%
LIBOR 0.237 -0.001 -0.31%
US Dollar Index (DXY) 80.67 -0.176 -0.22%
10 Year Govt Bond Yield 2.70% -0.01%  
Current Coupon Ginnie Mae TBA 105.9 0.0  
Current Coupon Fannie Mae TBA 104.8 0.0  
RPX Composite Real Estate Index 200.7 -0.2  
BankRate 30 Year Fixed Rate Mortgage 4.3    
Markets are up small this morning on no major news. Bonds and MBS are up small.
We don’t have a tremendous amount of economic data this week, although we will get the minutes from the October FOMC meeting. Analysts will be looking for clues regarding December. Remember the state of play from the Sep meeting – the Fed didn’t think the economic data warranted reducing asset purchases, but some felt like they had to do it anyway, just to maintain credibility. I don’t think the credibility argument really applies anymore, although the Fed may do a token move just to say they did it. Also the market seems pretty convinced that any changes will be on the Treasury side, not the MBS side. (That doesn’t mean mortgage rates won’t go up, they will)
Earnings season is largely over, except for the retailers. I think the consensus is that this year’s holiday season will be nothing to get all excited about. We will hear from the Despot tomorrow and Lowe’s on Wednesday. Wal Mart is watching closely to see if the obamacare insurance mandates hurt sales.
The future of Fannie and Fredie is still being worked out. The Senate has to balance the demand from liberals that the mortgage market serve all markets equitably and from conservatives that the taxpayer has to be protected. The goal is to wind down F&F and replace them with a re-insurer which will cover losses over 10%. Will Ackman and Fairholme play a role in this? That will be up to the courts.
Eminent Domain:  The bad idea that won’t die. Now Irvington, N.J. is considering. How many of these loans were CRA-driven in the first place? I wonder…

Morning Report – Private entities trying to force something with Fan and Fred 11/15/13

Vital Statistics:

Last Change Percent
S&P Futures 1791.2 3.5 0.20%
Eurostoxx Index 3057.4 3.7 0.12%
Oil (WTI) 93.88 0.1 0.13%
LIBOR 0.238 0.000 -0.15%
US Dollar Index (DXY) 80.88 -0.141 -0.17%
10 Year Govt Bond Yield 2.70% 0.01%
Current Coupon Ginnie Mae TBA 105.7 -0.2
Current Coupon Fannie Mae TBA 104.6 -0.1
RPX Composite Real Estate Index 200.7 -0.2
BankRate 30 Year Fixed Rate Mortgage 4.34
Markets are higher on no real news. Bonds and MBS are down small.
The Empire Manufacturing Survey came in lower than expected and import prices fell. Industrial Production and Capacity Utilization fell.
Bill Ackman has taken a 10% stake in Fannie Mae and Freddie Mac and may seek talks. This comes on the back of Fairholme’s bid to buy the insurance units of Fan and Fred. Fairholme’s bid would probably be denied by the government. Many in the financial community view the government’s changing the terms of the bailout just as Fannie and Fred became profitable as dirty pool. The government owns 80% of Fannie Mae and Freddie Mac’s stock and doesn’t have to do anything it doesn’t want to, but it certainly cannot relish the thought of dueling in the press with guys like Ackman, Pauson, and Berkowitz.
Housing affordability fell in the third quarter as prices rose and interest rates increased, according to the NAHB.
Janet Yellen’s testimony was pretty much as predicted. She is a dove. Reading the tea leaves, however it appears she is in no rush to begin tapering. Punch line:  I don’t know how you could have come out of that meeting thinking “I gotta short some bonds, right here.” Here is my longer take on it from yesterday: http://thenadtearsheet.blogspot.com/2013/11/janet-yellen-data-dump_14.html

Janet Yellen data dump

Janet Yellen testified in front of the Senate Banking Committee today and overall, there were few surprises. It is becoming clear that she intends to continue most of the Bernanke Fed’s policies, and to be honest I couldn’t find anything she would do differently. Her reception was generally good, and the Senators were respectful. Most of the questioning had to do with banking regulation, income inequality, the existence of asset bubbles and the size of the Fed’s balance sheet.

Here are some of the discussion points:

On current monetary policy: The Fed is seeking a strong and robust recovery, and must not jeopardize it by removing accomodation too early. She does not want to remove support while recovery is fragile. It is costly to withdraw accomodation or fail to provide adequate accomodation, and the Fed has the tools and the will to withdraw accomodation at the right time.

On asset bubbles: The Fed should attempt to detect asset bubbles when they are forming, however the first line of defense should be regulatory. Monetary policy is a blunt instrument and should be used if other measures aren’t working. She won’t rule out using monetary policy to address bubbles, but prefers that we use regulatory measures (such as increased capital requirements, higher risk retention requirements, etc) to prevent bubbles from occurring.  Separately, she sees little evidence that there are bubbles currently forming in the real estate market.

On banking regulation: Too Big To Fail imposes costs on the economy and should be avoided if possible. The government is making progress in handling too big to fail. They will raise capital standards further and the Fed is looking at requiring banks to issue additional unsecured debt at the holding company level to raise capital. She wants to ensure that the system isn’t set up to advantage the larger banks at the expense of the smaller banks.

On communication: In a nod to the volatility of the bond market over the summer, she said that she wants the Fed to communicate as clearly as possible with the markets and will redouble efforts to reduce volatility. This follows Bernanke, and is a departure from the Fed of the past, where they wanted to be as opaque as possible, lest the market anticipate what they were going to do, which would limit the effectiveness.

On QE and the balance sheet: Yellen was asked repeatedly about the effects of QE. She stressed that QE is being done to help the economy, not to help the government finance its deficit. When pressed about the size of the Fed’s balance sheet, she was forced to admit it is unprecedented for the US Central bank, but it was not unprecedented compared to other central banks. She acknowledged there are costs and risks to such a large balance sheet, and opposes any sort of Congressional audit of the Fed lest it reduce the Fed’s independence.

On income inequality: The Democratic Senators pretty much focused on income inequality, and what could be done about it. Yellen acknowledged that asset prices are rising, and that primarily benefits the rich, however the point of QE is to help the economy recover, and the best thing we can do for the middle class is to have a robust economy. She also acknowledged that QE is doing a number on seniors who rely on interest from safe assets to supplement social security. She views income inequality as a serious problem.

On the dual mandate: She stressed that the Fed must prevent inflation that is too low, and that deflation is a terrible thing. She refused to say what she thought “full employment” was, other than to give a range that it is probably in the 5% to 6% range. She also said that fiscal policy was working at cross purposes with what the Fed is trying to do. She also acknowledged that the reported unemployment rate understates the severity of the problem.

Key Takeaways:

While not admitting it, she seems to indicate the Fed goofed when it talked about withdrawing accomodation last June and causing the subsequent bond market sell-off. Expect the Fed under Yellen to be more communicative and she will probably try and clear up the confusion over tapering QE. It certainly seems she intends to err on the side of caution, provided there is no evidence of asset bubbles and inflation is at or below its 2% target rate.

The comment about full employment being in the 5% to 6% range was interesting as well. We spent many years over the past couple of decades with unemployment under 5% (it actually got below 4% in 2000). Does that mean the Fed will begin to start tightening before it ever gets to that level? Perhaps.

On asset bubbles, she does not hold the view that the Fed had a role in inflating the real estate bubble or the stock market bubble. Those bubbles were due to regulatory failure. It is ironic that the Fed has a problem with “too much money chasing too few goods” – in other words “inflation”, but is ok with “too much money chasing too few assets” – in other words a bubble. This is unsurprising; and suggests that the punch bowl might hang around a little longer than expected.