Yellen the Merciful: Fed Chair Offers Dovish Commentary on Rates, Will Focus on Balance Sheet Reduction

Stocks are liking this new Yellen, the merciful — as she hands out butterscotched candies to traders. According to Yellen’s testimony, the Fed is running out of room to raise rates and will focus on ‘appreciably’ reducing the balance sheet. It’s worth noting, Yellen is coming around to Fed’s Kashkari’s way of thinking, who rejected the idea that we needed to quickly raise rates in favor or reducing the $4 trillion balance sheet.

It’s an astonishing turn for Yellen, an attestation to Kashkari’s persuasiveness at the Fed.

Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance.

because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal. Even so, the Committee continues to anticipate that the longer-run neutral level of the federal funds rate is likely to remain below levels that prevailed in previous decades.

Source: BBG

On inflation, “it appears that the recent lower readings on inflation are partly the result of a few unusual reductions in certain categories of prices,” she says in prepared remarks to the House Financial Services Committee. She and the FOMC expect “the economy will continue to expand at a moderate pace over the next couple of years, with the job market strengthening somewhat further and inflation rising to 2 percent”
On domestic and foreign economic growth “should increase resource utilization somewhat further, thereby fostering a stronger pace of wage and price increases”

On uncertainty in the outlook: “There is, for example, uncertainty about when — and how much — inflation will respond to tightening resource utilization”… “I see roughly equal odds that the U.S. economy’s performance will be somewhat stronger or somewhat less strong than we currently project”

On monetary policy: “Because the neutral rate is currently quite low by historical standards, the federal funds rate would not have to rise all that much further to get to a neutral policy stance. But because we also anticipate that the factors that are currently holding down the neutral rate will diminish somewhat over time, additional gradual rate hikes are likely to be appropriate over the next few years to sustain the economic expansion and return inflation to our 2 percent goal”

On the balance-sheet runoff plan: “The Committee currently expects that, provided the economy evolves broadly as anticipated, it will likely begin to implement the program this year”

The Down is +160, Nasdaq +50 and the SPY +17. Crude is loving this news, +2%, gold +0.5% and the dollar is suprisingly higher by 0.44%.

The real action is in the bond market, with the 10yr down 5bps to 2.31%. European markets are all celebrating like they just won a war — higher by 1.5%.