Yellen’s Fed To Follow Bernanke Path For Now

This week marked the end of the Bernanke era at the United States Federal Reserve. After 8 years as the Fed’s chairman he is now part of the influential Washington D.C. based think tank the Brookings Institution effective February 3, 2014. Janet Yellen who served as Bernanke’s deputy is now the Fed’s chair. The first woman to hold that position at the U.S. central bank. Her nomination was not the Obama administration’s first choice, but the surprise withdrawal of Larry Summers swayed the tide to the economist circle’s choice.

Yellen will lead the Fed on a tapering course set by her predecessor. Bernanke on his next-to-last FOMC meeting reduced the size of the monthly bond-buying by $10 billion. The Federal Reserve was buying $85 billion a month prior to the meeting. The tapering continued into 2014 in his last FOMC as chairman when it was announced a further $10 billion would be pared back. Yellen has been part of the conversations and Bernanke assured markets in December that she was consulted on the moves.

It is now Janet Yellen’s challenge to stir the central bank through a turbulent global economic landscape. The Fed can with a simple statement bring about major movements. One example of this power was on display in the summer of 2013 when Bernanke announced the tapering. Emerging markets were immediately on the back-foot giving up the gains they had enjoyed in the year. Even though the taper did not start until the end of the year, the EM never recovered if anything their losses have compounded as tapering was validated by a second reduction.

The expectation is that Yellen will put her stamp in the Federal Reserve, but it will be a gradual change. The major policies have been put in place with her blessing and Bernanke made sure to stress that the Fed could stop the tapering and even reverse it, if economic conditions warranted it. Her relationship with the White House will be one to keep an eye out for as she was not their first choice as what she brought in terms of policy experience she lacked as a political operator. Larry Summers was the preferred choice but his surprise withdrawal left the door open for a different candidate.

The Bank of Japan will continue its monetary policy to support the objectives of the Abe government. Japan with Abe has managed to post positive inflation numbers, but more stimulus is needed to make this a permanent change. The BoJ and the Fed are on opposite sides of the spectrum which could support a weaker yen going forward. The depreciation of the currency has helped fuel the Nikkei returns in 2013, but at the cost of a growing trade deficit. A strange occurrence given the asian nation history as an exporter used to trade account surpluses. Employment is not a concern in Japan as inflation is the main target. Wage increases have been discussed between the government and the private sector as a way to insure inflation is fuelled by internal consumption.

The European Central Bank (ECB) is facing renewed pressure to cut rates after the latest inflation figures continue to point towards a possible deflation. Low inflation and high unemployment in the EU complicate the recovery of the economy going forward. The factors present in success stories such as Germany are not present in other countries that are dealing with austerity that has proven unpopular with voters.

Mario Draghi could be announcing another interest cut that would bring the rate currently at 0.25 percent rate to a new record low. The ECB’s inflation target is 2 percent. The latest reading brought overall inflation at 0.7 percent in January putting the central bank in a tough spot as the market will be looking at them for guidance this week.

This week the Bank of England will probably keep rates on hold as stronger indicators have been reported. Employment and manufacturing continue to fuel optimism about a sustained recovery. Inflation continues to be around the 2 percent benchmark, so no immediate concern for the central bank.

BoE Mark Carney has downplayed forward guidance, specially after tying the central bank’s actions to a fast recovering job market. Unemployment has reached the 7 percent level faster than forecasted by the Bank which could not raise rates at this point. The central bank has said it needs to work on how to evolve forward guidance to offer transparency without having an unwanted impact in the markets. This is something the Fed has also struggled with as the unemployment rate keep dropping putting pressure on the US central bank to raise rates. The Fed moved away from tying policy to a single indicator in the eyes of the market, something the BoE is considering. Later this month the BoE will report how it will communicate its intentions going forward.

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Alfonso Esparza

Alfonso Esparza

Senior Currency Analyst at Market Pulse
Alfonso Esparza specializes in macro forex strategies for North American and major currency pairs. Upon joining OANDA in 2007, Alfonso Esparza established the MarketPulseFX blog and he has since written extensively about central banks and global economic and political trends. Alfonso has also worked as a professional currency trader focused on North America and emerging markets. He has been published by The MarketWatch, Reuters, the Wall Street Journal and The Globe and Mail, and he also appears regularly as a guest commentator on networks including Bloomberg and BNN. He holds a finance degree from the Monterrey Institute of Technology and Higher Education (ITESM) and an MBA with a specialization on financial engineering and marketing from the University of Toronto.
Alfonso Esparza