Mizuho daily – Uninspired … taking the “Yell” out of Yellen(‘s words)

By Vishnu Varathan, Head, Economics & Strategy, Asia & Oceania Treasury Department, Mizuho Bank, Ltd.,

Uninspired …

Lackluster markets mostly as Nasdaq’s gains were offset by losses on S&P500 and Dow while UST yields were lifted modestly between 1-1.5bps across the curve.  Whether this is uninspired post-NFP markets or nervous pre-CPI markets watching for US inflation cues is debatable. But not revelatory either way.

Some slippage in the USD meanwhile has meant that this is not a “risk off” market per se; but equally, PBoC resisting excessive CNY strength means SGD bulls are not breaking below 1.32.

AUD may have edged above mid-0.77, but no real “Risk on” rally to be seen anywhere. USD/JPY on a fairly short leash around mid-109 while EUR uptick to 1.22 remains hesitant.

Yellen’s inflation allusion though may mean markets hold back ahead of US CPI data.

Taking the “Yell” Out of Yellen(‘s Words)

It appears that any time Treasury Secretary (and former Fed Chair) Janet Yellen alludes to higher interest rates, markets appear to react as if “normalization” is being yelled at them.

But this is either an overreaction, if not an outright misconception. For a start, the wider context is critical here. And that simply is that Yellen’s starting point is backing Biden’s record fiscal spending (now ballparked at) $400bn per year.

Not only is her point that this is far from mindless fiscal profligacy, but more technically that this is not fiscal stimulus but rather, structural capacity building that is needed to boost US economic capabilities over the longer run.

And that is her core proposition in her capacity as the US Treasury Secretary.

Whereas the inflation reference is a by-product of the fiscal spending/investment stance. And even here her position is far more nuanced.

The underlying principle is that insofar that a large component of US fiscal spending is infrastructure/capacity building, the supply-side enhancement ought to subdue, not amplify, overheating risks.

The default therefore is that fiscal spending, on its own, will not ultimately be inflationary for  the economy; not to the point that inflation expectations become untethered.

But what has been conceded (implicitly) is that the complex and hard-to-predict interaction of a multitude of;

• cost-push factors;
• current capacity constraints;
• post-pandemic pent-up demand and;
• speculation may have unforeseeable inflation outcomes

And it is in this context that Yellen alludes to the possibility of higher inflation; and not as a base case, and certainly not as a mechanical reflex to fiscal spending. And her main thrust is that she has confidence that any such inflation threat will be dealt with effectively by the Fed; not that the Fed will imminently be forced to react to inflation.

More importantly, her allusion to higher inflation not necessarily being a bad thing (for the Fed and economy) is presumably the reference to economic recovery and the attendant normalisation from exceptionally low (effectively zero) rates.

In fact, she may be recognising  that exceptionally low interest rates bring with it a litany of problems; from asset bubbles, to  potential for destabilising capital flows to productivity perversely hampered by misallocation (from mispriced credit).

But there is no doubt that she recognized the importance of current policy mix, albeit state-dependent as the Fed itself has signaled, to reinforce the recovery that is underway.

So, to be clear, Yellen’s inflation views are neither at odds with the Fed’s “deliberate patience” to look through transitory cost pressures; nor is she surreptitiously prescribing a different course of action for the Fed.

Which is to say that UST markets have no reason to (over) react to Yellen’s comments as yet. Not until more economic evidence is revealed.