Blog : Janet Yellen's Bullish Effect

by Ed Zwirn on February 12th, 2014

Janet Yellen has proven once again that she is good for stocks. Her Congressional testimony yesterday -- her first since taking the helm at the U.S. Federal Reserve -- resulted in a pronounced rally for stocks, with the Dow Jones Industrial Average finishing up 1.2% on the day, the NASDAQ Composite ahead 1% and the penny stock-rich Russell 2000 up 0.9%.

This is not Yellen's first beneficial impact upon the market. The Dow rose 3% on the Monday following the September announcement that Yellen's main rival for the post, former Treasury Secretary Larry Summers, had bowed out of the race, and the broader market followed suit, to the delight of penny stock investors.

The reasons for Yellen's beneficial effect on stocks have been widely noted. For one thing, she has been a consistent advocate of using the U.S. central bank to promote employment (and with it the stock market). Moving up to her position from Fed vice chair, Yellen also personifies the stimulus-oriented Fed that investors have come to know and love, and her elevation (even as predecessor Ben Bernanke remains on the FOMC board) means that these policies will continue for the foreseeable future.

At its January meeting, the Fed decided to make a further reduction of its quantitative easing program, bringing the monthly shot in the arm received by financial markets down to $65 billion, versus the $85 billion it had been pumping into the economy late last year. Yellen, in her opening statement to Congress, committed herself to continuing this "taper," but refused to be hamstrung by it.

"If incoming information broadly supports the Committee's expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings," she said. "That said, purchases are not on a preset course, and the Committee's decisions about their pace will remain contingent on its outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases."

Yellen also used her Congressional platform to stress that the other key pillar of the Fed's stimulus, low interest rates, will probably continue for some time despite the reduction seen lately in the U.S. unemployment rate. In December 2012, the Fed said that it expected the current low target range for the federal funds rate to be appropriate at least as long as the unemployment rate remains above 6.5%, inflation is projected to be no more than a half percentage point above its 2% longer-run goal, and longer-term inflation expectations remain "well anchored."

Inflationary expectations may remain "well anchored," with the Consumer Price Index still well below the Fed's inflation target, but the employment situation has seen a degree of improvement that puts it (some would say) perilously close to the Fed target, running most recently (in January) at 6.6%.

"Crossing [either the unemployment rate or inflation threshold] will not automatically prompt an increase in the federal funds rate, but will instead indicate only that it had become appropriate to consider whether the broader economic outlook would justify such an increase," she said, adding that "it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5%, especially if projected inflation continues to run below the 2% goal."

"I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2% while ensuring that it does not run persistently above or below that level," she said.

Of course, the U.S. economy is nowhere near either full employment or a 2% inflation rate, but Yellen's reassurances resonated all the same in a stock market which has come under pressure so far this year, in large part because of global concern over the course of Fed policy.

Quantitative easing has had the (perhaps) unintended consequence of boosting speculative investments across the board, as investors hungry for yield snapped up emerging market investments, penny stocks and other riskier plays.

The new Fed chair is probably not in for a "honeymoon" as she begins to make her mark on the financial world. There will be plenty of opportunity for unforeseen events and grandstanding politicians to insert themselves into the economic dialogue as this year progresses. There will also be continued pressure on the Fed as it tries not to overreact to each market wrinkle that presents itself.

That being said, the ability that Yellen has so far exhibited when it comes to boosting markets has probably yet to play itself out. Her commitment to using the Fed to promote jobs is not only smart talk politically, it also means good news for the companies, large and small, that are expected to create these jobs.