“Yellen and Cisco lift US stock futures,” the headline read enticingly in the morning. Priceless. Their combined pronouncements were driving up the markets, it seemed. Cisco CEO John Chambers is famous for adding adjectives during earnings calls that cause or predict crashes; his use of “very lumpy“ to describe demand for Cisco products in November 2007 unleashed a round of mayhem. But to everyone’s great relief, he kept any errant adjectives to himself during the earnings call, though he did admit that the “macroeconomic environment” was “challenging” and that “order trends in Europe” were “very challenging.” But not “very lumpy.”
The other spark that goosed the futures, according to the headline, wasn’t a corporate giant, but Federal Reserve Vice Chairman Janet Yellen who is rumored to have a shot at becoming Chairman, if Ben Bernanke decides to abandon ship in early 2014. Her words weigh. So late yesterday, she extended the Fed’s Zero Interest Rate Policy (ZIRP) even further. It had already been extended and re-extended and now is scheduled to run until mid-2015. But she extended it to eternity apparently when she said that she was “strongly supportive” of decoupling rate increases from the calendar and pegging them instead to the unemployment rate.
She followed in the footsteps of Chicago Fed President Charles Evans, who’d proposed to keep ZIRP effective until the unemployment rate dropped to 7%. Minneapolis Fed President Narayana Kocherlakota too had backed that idea, but his trigger would be an unemployment rate of 5.5%! An elusive date is to be replaced by an equally elusive unemployment rate. ZIRP forever!
Yellen also explained that the Fed’s 2% inflation target—based on PCE, so maybe 3% CPI—is not a “ceiling” but a guideline. Or perhaps a floor; a policy that might lower the unemployment rate, she reassured us, would lead to inflation above the guideline. So her plan is clear: wealth confiscation will continue through yields that will remain below inflation year after year until bond investors and savers have been bled dry. And if investors don’t like getting bled dry the slow way, the Fed keeps implying, they need to invest in riskier assets, such as the stock market, in order to re-inflate the bubbles that had been so devastating already.
But by the time the markets closed, the manipulative power of Yellen’s words had dissipated, and the DOW was down 1.45% for the day, at a time when a 10-year Treasury note yields 1.6% in a year! So savers, plow your savings into the stock market. The Fed wants you to.
With impeccable timing, that’s exactly what the German Bundesbank warned about in its annual Financial Stability Report. The “massive monetary and financial policy measures” used to stabilize the financial system “led to an ever greater transfer of risk to the public sector and to the solidification of the environment of low interest rates, the report explained. The side effects of the short-term stabilization could in the medium and long term prove to be “a burden for financial stability.”
It warned that the longer the low-interest-rate environment dragged on, the more irresistible the incentives would be to shift financial means from low yielding, comparatively safe assets to higher yielding, but “more hazardous assets.” And chasing yield has intensified: yields and risk premiums of European corporate bonds have “dropped significantly” despite “clear signs of economic cloudiness and higher risks of default.”
The report pointed out that low yields jeopardized the conservative investment portfolios of life insurance companies. Their products, which offer guaranteed minimum yields, are a popular tool in Germany for building retirement income. To keep their chin above water, life insurance companies were investing in higher risk assets—such as infrastructure projects. In the process, they pushed down those yields further, exposed themselves to more risk, and invaded the turf of banks. It all could ultimately “jeopardize future financial stability.”
It was a resounding slap in the face of the Fed. Which it brushed off by ignoring it publicly.