Yellen Slams Another Nail in the Coffin of the Stock Market

The Federal Reserve Chairwoman Janet Yellen appeared last Wednesday before the House Financial Services Committee to discuss the economy and monetary policy. Investors, including myself, were eagerly waiting to see a strong and clear dovish sign regarding future interest rate hikes. Such a sign is desperately needed to give some reassurance that the Fed is aware of the current global risk and willing to take action; unfortunately this did not happen. As I was listening to the speech and statement by Ms. Yellen, I felt disappointment and a sense that the Fed is not on top of things. I am going to comment on some key areas she made during the speech.

Comments about The state of the US Economy:

Ms. Yellen stated that “Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar.”

My question is when did all this happen? The Fed just raised interest rates on December 16, 2015, less than 2 months ago, citing with unprecedented confidence a strong outlook for the US economy. Going back to December 16, 2015, Ms. Yellen stated during a speech that followed the rate hike announcement: “The US economy has shown considerable strength …With the economy performing well and expected to continue to do so…This action (rate hike) reflects the Committee’s confidence that the economy will continue to strengthen”.

Is it possible that the outlook to one of the world’s biggest and strongest economies can deteriorate and reverse so quickly, in just 56 days, from a strong outlook to a less supportive outlook? This “sudden” deterioration is hard to swallow.  At first sight one can conclude one of two things:

• Either the Fed made a grave mistake in December when it raised the interest, which is fine. It can admit to it, and attempt to rectify the situation; or
• The Fed is unable to estimate and predict the short-term risks at play and how they can come back to put a dent to the US economy.

Culprits for the deteriorating outlook

The Main Risks cited by Ms. Yellen for the deteriorating outlook:

• “A stronger dollar”: The risk of a rising US dollar is not a new one. The dollar index has been gaining strength over the past few years, hurting the US economy by curbing exports and making US goods less competitive. If this is a strong risk factor, why were its effect not spotted earlier, when the Fed raised rates last December adding upward pressure on the US dollar?
• “Decline in Equity Prices”: Did the Fed expect that equities were going to stage a strong rally, following a rate hike, while the global economy is fast deteriorating and facing severe deflation, and while markets across the world are free falling?
• China: Ms. Yellen commented that the most notable risks come from China, with the main one being declines in the Chinese currency — “declines in the foreign exchange value of the renminbi have intensified uncertainty about China’s exchange rate policy and the prospects for its economy.”

If we go back a couple of months to early December, China had sent a clear message to the Fed early, prior to the rate hike, urging the Fed not to go ahead with its plan, stating that  any US rate increase will be detrimental to the Chinese economy. The Chinese main concerns were that higher US interest rates will result in a stronger US dollar, putting additional pressure on China to devalue its currency, due to the fact that Chinese Yuan was pegged to the US dollar. Unfortunately the plea was not heard by the US Fed. Could this be another risk miscalculation by the Fed regarding its rate hike, and its direct detrimental impact on the Chinese currency and on the global economy?

Janet Yellen had a great chance to act and fix things on Wednesday, but she decided not to, or rather was unable to. The resulting inaction, and what may seem to be a lack of clear vision, is likely to reduce investor confidence and cause further deterioration of the US economic outlook.  In the meantime, investors and market makers are likely to send a clear message to the Fed through deeper global market declines and heightened volatility.

 

This article is a guest blog written by Rida MORWA, editor of Retire with High Dividends, a newsletter dedicated to bring investors the most profitable and newest high-dividend ideas. To learn more click here.