Yellen Faces a Catch-22 Dilemma
Given that short-term interest rates are close to zero, Yellen’s ability to surprise markets to the upside depends largely on the shape of the yield curve. If the curve discounts a high degree of tightening, then she can create a rally by simply not tightening or tightening less than what is priced in. A flat curve means this source of fuel for markets is largely gone.
It is true that negative interest rates and more QE are possibilities, but neither are politically palpable and neither have much room to run anyway. Her third option is of course to bluff. I believe this is what she has done for the past year. The dot plot of future interest rate expectations that she releases on a quarterly basis has implied a path of tightening far out of line with reality. That level of tightening was never on the table, but it at least forced markets to partially build it into their expectations.
This is precisely why she has not taken a March rate hike off the table when everything would point to a substantial delay in further rate increases. When she does not tighten in March, she will likely talk up a tightening in June. The more buffer she can get, the better.
Yellen’s dilemma is that she has very little to work with in a highly volatile time when US monetary policy is more important than ever. How she manages her resources and the intelligence of her signaling strategy will determine a great deal for both the US and beyond. On one hand Yellen’s most prudent course of action is to maintain loose monetary policy. On the other hand, such decisions put the US economy in an unsustainable cycle of addiction by inflating stock market pricing to unsustainable levels and making future stimulus less likely to be effective.
Read this article by Katina on Forbes by clicking here.