Waiting for a nod and a wink from Yellen

It’s been a pretty dull week for markets.

There’s a reason for that. Psychologically speaking, they’re on hold ahead of whatever comes out of the big central banker’s jamboree at Jackson Hole in Wyoming tomorrow.

Donald Trump might get all the headlines. He might be able to spark the odd tremor in the S&P with some idle talk of nuclear war, or his apparent inability to do anything.

But the market really only has eyes for one woman.

Central bankers and tractor parts

Every year, the world’s central bankers gather in Jackson Hole, a resort in the US state of Wyoming. They don’t actually set interest rates or anything like that. But they do give their views on what’s going on in the world. And increasingly, pretty much any cough, sniffle or eyebrow shift from central bankers will move markets in this low-rate dependent financial universe.

No central bank in the world is more important than the US one, the Federal Reserve. And that means that Janet Yellen, the Federal Reserve boss, is the world’s most important central banker, and therefore, pretty much the most important person in the financial sphere.

Having quite so much money riding on the ability of one person to a) make good choices within a highly limited framework, and b) to communicate those choices to the markets in a way that avoids misunderstandings, doesn’t strike me as being healthy for markets or capitalism or any of those other things that we’re meant to believe in.

I could rant for ages (and I have in the past) about the absurdity of the world’s capital allocators waiting with bated breath to hear what hint Yellen might drop next. If we were instead waiting for her to outline her views on achieving a global quota for tractor parts over the next year, rather than talking about the money supply, we’d perhaps be able to see the contradiction.

But money confuses us, even – perhaps especially – those who are paid to invest it. It’s too abstract.

Anyway. It is what it is. So, what does all of this nonsense mean for investors?

Why you can expect Yellen to play it safe

The truth is that, unless you’re a short-term trader, you can probably ignore Jackson Hole altogether. You certainly shouldn’t be positioning your portfolio on the basis of something as ephemeral as central bank policy.

Trouble is, a lot of people do. So if you want to understand why markets move the way that they do and how far from “free” and narrowly rational they are, then it’s not a bad idea to wrap your head around reactions to central bank announcements.

The basic issue here for investors is pretty simple. Will Yellen be more hawkish than the market expects, less hawkish, or pretty much in line with market expectations?

If she’s more hawkish, the US dollar goes up, gold goes down, and stocks probably fall (stocks only like talk of rising rates if they feel confident in the strength of the economy and I’m not convinced they do right now). If she’s more of a dove than expected, then the dollar will falter, gold likely go up (maybe even breaking through the $1,300 an ounce mark), and stocks will probably hang on to their recent bounce.

So, what’s it to be?

Yellen’s big talk on Friday is about “financial stability”. And on the “hawkish” side of the argument, as John Authers points out in the FT, the Fed is increasingly worried about asset prices. In the minutes from its latest meeting on monetary policy, it noted that “the vulnerabilities caused by asset valuations were now ‘elevated’”.

Adds Authers: “The Fed will be conscious of lessons of ten years ago, which were that the central bank disastrously failed to nip bubbles in equities and housing until it was too late.”

That’s a fair point in theory. The only quibble I’d have with it, is that I’m not sure the Fed really blames itself for not “nipping” those bubbles.

Former Fed boss Alan Greenspan – the man who effectively formalised the idea of central banks as a giant safety net, ever-ready to catch over-reaching financiers, regardless of the consequences for the rest of society – always said that popping bubbles was not the Fed’s business. Who knew when a bubble had got out of hand? Better to clean up afterwards.

And I’m not convinced the Fed’s view has changed on that. These are academics we’re talking about, and fairly old ones at that. They still believe that markets are efficient. At some instinctive level, they still question the very existence of bubbles. They still profess shock when markets behave in apparently non-rational ways. They see events like 2008, and 2000, and 1997, and all the rest of them, as bugs rather than integral features of the current system.

So, regardless of how concerned she might be about the huge overpricing in the US stock market, I don’t see Yellen taking any major practical steps to tackle it.

It’s easier to have courage when every choice is a bad one

Meanwhile, she has every excuse she needs to be reticent about tightening policy. Inflation remains below target, despite rising employment. There is no immediate need to take away the punch bowl, as the Fed’s job was once described.

To be fair to Yellen, the problem with being the Fed boss is that if you take away the punch bowl, and the party turns sour, then everyone blames you. You need a good excuse to take it away.

People talk about Paul Volcker (who was in charge in the early 1980s) being a courageous central banker. He was. But ironically enough, it’s easier to be courageous when all of your options are bad ones. You can hike interest rates hard when the alternative is inflation rising above 30%.

Right now, that’s not where we are. If the Fed tightens too sharply, then all the people whose good opinion Yellen craves (she’s human, like the rest of us) will talk about “unforced policy errors” and the Fed repeating the mistakes of the 1930s.

So, overall, I’d expect Yellen’s message to be “steady as she goes”. She’d like to raise an eyebrow at asset prices, but only gently. The message she’d like to give is: “I’d rather not see asset prices go up much further for a little while at least; but I really, really don’t want to see them crash.”

And I’m sure markets will take her at her word.