News Column

Dr Yellen's epic monetary blunder

June 23, 2014

The Federal Reserve sees economic slack as a rationale to tolerate higher target inflation.

Dr Janet Yellen has just committed the biggest blunder of any recent Federal Reserve chief, comparable to Bernanke's failure to stem subprime excesses and Greenspan's green light for the repeal of the Glass Steagall Act.

Yellen's failure to deliver a hawkish message on inflation, despite hints about a potential 2015 rate hike, the risk of leveraged speculation and stronger US growth, led to explosive rallies on Wall Street, a rise in euro/dollar above 1.3620 and fall in dollar/yen below 102. The subliminal message? The Federal Reserve sees economic slack as a rationale to tolerate higher target inflation. There are no bond vigilantes in Chicago (for now), so the 10-year US Treasury note yield drifted lower to 2.62 per cent. This could (and will) change once CPI rises above two per cent or Brent spikes above $120 if Iraq's civil war escalates or US Tomahawk cruise missiles are launched from the naval flotilla now in the Gulf. It is surely symbolic that the aircraft carrier is the USS George HW Bush, named after the president who liberated Kuwait from Saddam Hussein's armies during Desert Storm.

For now, Yellen's Press conference convinced me to buy risk assets on Wall Street and stay long currencies with hawkish central bank and accelerating economic data. This means stay long the British pound, Kiwi (New Zealand) dollar and the Mexican Peso.

I believe Dr Yellen (a fellow one-time resident of Bay Ridge, Brooklyn!) made a strategic mistake in not making any reference or expressing any concern about inflation at a time a major war looms in Iraq and El Nino/Ukraine means food inflation. An oil price spike could lead to the return of the bond vigilantes, a violent and disproportionate selloff in the US Treasury bond market and the resurrection of the "Fed is behind the inflation curve" monetary Cassandra.

That will mean higher vols, Black Death in the carry trade (watch the Indian rupee, South African rand, Turkish lira. Big ugly moves are imminent!). Dr Yellen should have established her anti-inflation credentials at the onset, as Volcker and Greenspan once did. She did not. America and the world will play a terrible price for her failure. Rising inflation pressures, sooner or later, will unnerve Wall Street. Yellen, at that point, will have no credibility with the bond market and the 10-year US Treasury note will spike to 3.5 per cent and wreck carnage in global markets. The ghosts of 1994, in life and the markets, still haunt me.

Philly Fed, jobless claims, FedEx results, steel/freight trends, home prices, equities, car sales and credit card debt all mean the US economy is strengthening. So it is absolutely insane for Yellen to give the markets a "risk lollipop" and not explicitly tie inflation risk to monetary policy. No wonder long-term Fed funds futures rallied as Chairwoman Yellen sleepwalks into one of history's next big monetary policy ambush.

It is strange to see the euro trade above 1.36 on Yellen, not Draghi or the realities of European banking, politics or Club Med, let alone Brent, Russia, Ukraine, LNG and Iraq. This Yellen pop give me better levels to scale into my euro shorts above 1.3620. Patience, like vengeance, is a dish best eaten cold.

Stronger crude oil, better US data, a dovish Fed, high risk appetite, better trade data are all positive for the Canadian dollar. Yet while the loonie can trade as high as 1.07 on Yellen's Hunky Dory worldview, Governor Poloz knows oil spikes, Mideast unrest and a stronger loonie are not benign for export growth. So the Bank of Canada will turn dovish again and the Canadian dollar will once again depreciate to 1.13. As the Norges Bank proved in Oslo, when a central bank disappoints, currencies have heart attacks as the Norwegian Kroner did.

Even though sterling is no longer cheap, the Old Lady (actually, Young Canuck) of Threadneedle Street is on the war path and eager to scalp sterling bears. I want to reenter cable at 1.6980 if we see it this week.

Researched and compiled by Matein Khalid. Mr Khalid is a global equities strategist and fund manager. He can be contacted at:

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Source: Khaleej Times (United Arab Emirates)

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