Yellen's Biggest Early Challenge

02/12/2014 11:00 am EST


Jim Jubak

Founder and Editor,

Yesterday, New Federal Chairman Janet Yellen delivered her first congressional testimony, and while the financial markets liked what she said, MoneyShow's Jim Jubak feels there is still a big hurdle left for her to jump.

New Federal Reserve Chairman Janet Yellen delivered her first congressional testimony yesterday in front of the House Financial Services Committee.

And financial markets liked what they heard. As of 1:30 PM New York time yesterday, the Dow Jones Industrial Average (IX:INDU) was up 1.23% and the Standard & Poor's 500 (SPX) 1.03%. Germany's DAX Index (DAX) closed up 2.03% on the day and in Asia, where markets closed well before Yellen started to talk, Japan's Nikkei 225 Index (NKY) was up 1.77%, Hong Kong's Hang Seng (IX:HSI) was up 1.78%, and the Shanghai Composite (IND:SHCOMP) was ahead 0.84%.

Yellen stressed continuity with former Fed chairman Ben Bernanke's policies. The Fed would continue to reduce its purchases of Treasuries and mortgage-backed securities at a speed dependent on the economic data. The slow pace of job creation in December and January was certainly disappointing, but, Yellen cautioned, two months of data wasn't enough to bring a change in the central bank's taper policy. The Fed's Open Market Committee doesn't meet again until March, she noted, and that will give the bank another month of data to examine.

Most importantly, Yellen successfully—for the moment—addressed the market's anxiety about the falling unemployment rate. Remember that, once upon a time, the Fed had said it would keep short-term rates near zero until the unemployment rate hit 6.5%.

Well, in January, the unemployment rate hit 6.6%—near the mark—but most of the improvement in the unemployment rate has come from a big drop in the labor participation rate. The unemployed (and other workers) aren't finding jobs, so much as, they're leaving the workforce.

In recent months, the Fed has said that the unemployment rate isn't the only indicator that the central bank is watching. Yesterday, Yellen said that, besides the unemployment rate, the Fed was watching job creation, wages, and inflation.

That's reassuring to a financial market that has grown increasing comfortable with the assumption that the Fed will stick with current low short-term rates until, at least, the mid-point of 2015.

But Yellen's comments don't add up to a clear message to the market on what the Fed will be watching. And coming up with a formula that the Fed can clearly communicate to the financial markets, remains her biggest early challenge.

In the coming weeks, watch the derivatives market to see what it's betting on, as to when the Fed will start to raise short-term interest rates. Recent data showed the derivatives market pricing in a 50% chance of an interest rate increase by the Fed's July 2015 meeting.

Full disclosure: I don't own shares of any of the companies mentioned in this post in my personal portfolio. When in 2010 I started the mutual fund I manage, Jubak Global Equity Fund, I liquidated all my individual stock holdings and put the money into the fund. The fund may or may not now own positions in any stock mentioned in this post. For a full list of the stocks in the fund, see the fund's portfolio here.

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