Yellen didn't answer the main question at Humphrey Hawkins but she dropped some important hints
The main question ahead of Humphrey Hawkins testimony from Fed Chairman Janet Yellen was would she indicate the Fed was prepared to remove 'patient'
Unfortunately, there were no definitive answers on Tuesday. The market initially misinterpreted the headlines as if 'patient' was removed but Yellen only talked in hypotheticals. Still, Yellen appeared as though she was to prepare the market for removing patient at the March meeting. The main point of her testimony was to emphasize that when 'patient' is removed, it gives the Fed the option - not the obligation - to hike rates at future meetings.
That isn't a big surprise but between the lines there were four things Yellen touched on that indicate what the Fed is thinking.
1) Not the foreign economy you would think
The US economy might be strong but the global economy is weak. The obvious culprits are Europe, Japan and the commodity producers but the first economy Yellen singled out was none of them. Instead, she named China.
Foreign economic developments, however, could pose risks to the outlook for U.S. economic growth ... In China, economic growth could slow more than anticipated as policymakers address financial vulnerabilities and manage the desired transition to less reliance on exports and investment as sources of growth.
The takeaway
The comments itself doesn't jump off the page but that she mentioned China first indicates that's the economy the Fed is watching most closely and is most worried about.
2) Jobs still not that strong
Yellen touched on three labor market indicators that don't get the same attention as the unemployment rate. 1) The pace of quits. She noted it has recovered nearly to its pre-recession level. 2) Participation. The Fed had been wishy-washy on how it sees the participation rate but she was clear in saying that it's "lower than most estimates of its trend."3) Underemployment and discouraged workers. In the Q&A, Yellen said U6 underemployment 'definitely' shows a less rosy labor picture than the unemployment rate.
The takeaway
Even after a blockbuster January employment report, the Fed still isn't convinced on the jobs market although Yellen expects continued progress.
3) The inflation puzzle perplexes
Wage inflation might not be the story of the year, it might be the story of the decade.
"Wage growth remains sluggish," Yellen said in her prepared remarks.
"The fact that wage growth has not picked up much during this recovery, I take it to be another signal that although the labor market is improving we have further to go to promote full recovery," she said in the Q&A.
The wage question ties into the obscure inflation picture. Yellen continued with the idea that oil price disinflation should be disregarded, or 'looked through' and that's a fair point but the Fed is clearly struggling to understand inflation.
The Fed also continues to disregard breakevens while focusing on inflation expectation surveys and surveys of professional forecasters. The bond market implies 1.46% average inflation over the next 5 years. "As far as we can tell," Yellen said. Breakeven rates "mainly reflect factors other than a reduction in longer-term inflation expectations.
That's a dangerous assumption and the inclusion of 'as far as we can tell' in the prepared statement, indicates that the Fed is loath to second-guess the market.
The takeaway
The talks a confident game about 'looking through' oil price disinflation but under the surface, The Federal Reserve is deeply uncertain and, at the very least, wants to see more wage inflation before committing to anything beyond a token rate hike.
What it all means for the market
On the whole it's dovish. Coming into the testimony, traders expected Yellen to take the opportunity to strongly hint that 'patient' will be removed in March but there was hardly a hint at all. Instead, she highlighted some of the reasons not to remove it. That US dollar has weakened as a result, including a nearly 1 cent drop versus the yen.
The kneejerk move may be overdone. In the bigger picture, the comments still set up the Fed to remove 'patient' in March even if that doesn't guarantee a hike in June. In trading terms, dollar dips remain buying opportunities for the simple reason that even if Yellen was slightly less hawkish than expected, the Fed is still far closer to raising rates than anyone else.
