Yellen’s Enigma
Hindsight is 20/20. That being said, 2015 saw a bull run in the US dollar that was forecast by many credible analysts. The year also saw commodities tumble and other assets that are negatively correlated to the US dollar show weakness, particularly the Canadian dollar. Now, looking ahead to 2016, the Bank of Canada is no longer viewed or anticipated to be more accommodative. The federal government has planned stimulus spending to ‘invest’ in the Canadian economy. And surprisingly, we have seen somewhat strong economic indicators in the first few months of 2016 despite heightened levels of uncertainty from the global economy over same time period.
It’s worth reconsidering what factors drove the loonie and oil prices to the levels they are today. A major contributor to sharp movements in the global currency markets was the US Federal Reserve out in front in terms of tightening monetary conditions. With steadied and continued improvement in the US labour market, the Fed prepared to gradually raise their key policy interest rates. And, with regards to commodities markets, the world economy faced both weakening demand, particularly from China and the emerging economies and an oil supply glut that focused heavily on shale production in the US.
The reason it’s worth revisiting those two aforementioned factors that caused such disruption for global markets, is because they currently remain at the forefront of what’s driving investment markets. Janet Yellen was speaking at the Economics Club of New York this past week, and seemed to do a course change on how the Fed views international developments. What was previously not a concern of the US Federal Reserve and just a mere acknowledgment in their prior policy statements suddenly became a focal point of Ms. Yellen’s speech. Following the Fed’s initial rate hike in December, anticipation was for four additional quarter point moves this year. Now the question is whether there will even be two.
Regarding commodities, there is still clouded uncertainty over whether OPEC members will come together to cut production levels and assist in putting a floor under the oil market. This question will have greater clarity by the middle of this month when OPEC and Non-OPEC producers meet, but at this time oil prices are a factor that continues to weigh on commodity markets, as the possibility of lower prices is continuously debated.
This in essence represents Yellen’s paradox, and it seems she is willing to delay and shift back to a wait and see approach. Her enigma is heightened by the fact that a strong US dollar stemming from central bank policy in tandem with a supply glut in commodities led to dogged market volatility. Many of her fellow Fed members have been vocal these past few weeks, and appeared ready to continue to hike rates. Other members, including Yellen, have seen how a strong US dollar has challenged the US economy with the expectation of a Fed rate anticipated with a vibrant US labour market. While waiting, however, the Fed risks their credibility of being able to raise interest rates as they had previously guided investors to believe.