Yellen Helps to Boost the US Dollar

Greg Michalowski |

Janet Yellen, Fed stock market comments, BOE Governor Carney, banks solvency

Fed Chair Janet Yellen testified in the Senate on July 15 and apart from reiterating talking points already made during past press conferences and speaking engagements, she did catch the attention from two separate comments.

The first was not from her testimony but in a supplementary written report that she submits along with her formal testimony.  In it she commented that:

"...valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.

The action has led to declines in those stocks today, and has had an influence on the Nasdaq index as well.  

The question for me is "Does the Fed have a duty or responsibiity to specifically target sectors in their official policy statements?"  

Personally, I would prefer if the Fed keep their specific stock market comments to themselves and instead focus on the those things that they are responsible for, like inflation, employment and increasingly more important post-2008, the overall safety of the financial sector.

Having said that, if the value of stocks - whether it be social media, biotech or other sectors - are rising as a result of an overleveraged situation, and that threatens the financial system as a whole, speak up, act - do what you can do to prevent another financial meltdown.  

This specific comment, talks simply to their interpretation of valuation metrics that suggest the prices in a subset of a larger set, may be too high.

In contrast to the Fed's action/comment, the Bank of England addressed a similar issue. Specifically, BOE Governor Carney addressed the concerns of a potentially overheating housing sector. However, he did not specifically address the fact that price of homes may be too high. Instead he focused on the banks and their risks.  

The BOE proposed that banks do a stress test on their loan portfolios to a 3% shock increase in rates to see, how that might impact the banks solvency. They also proposed that banks limit the amount of new loans to those with high mortage to income ratios. In other words, they addressed over leverage in the banking sector and solutions for controling it.  They don't necessarily want to prevent home prices from rising if the demand is there, but instead to make sure to avoid another banking meltdown..  

The Fed did not address a threat to the financial system. Yes, there may be some overvaluation but will a decline in those sectors, take down the economy?  Will it threaten the banking system as a whole? From what they said, it seems not to be the case. 

Let it be, Fed. Let it be.

The second comment was included in the main text of the Chairwoman's testimony. Specifically, she commented that:

"...gains in total nonfarm payroll employment average about 230,000 per month over the 1st half of this year...The unemployment rate has fallen nearly 1 1/2 percentage points over the past year...Broader measures of labor utilization have also registered notable improvements over the past year"

This comment has helped to give the dollar a boost in trading today as it suggests a shift in the Fed's interpretation of the employment picture. Specifically, the glass seems half filled rather than half empty, and that the employment situation has reached a positive tipping point.  The fact that the Fed has also communicated that the QE would most likely end in October, is another admission of that confidence in the ball continuing to roll forward. 

The chart above shows the percentage change of the US dollar versus the major currencies and apart from the GBP (which benefitted from higher than expected CPI data today), the US dollar has risen against all the other major currencies on the positive assessment of the US employment situation. Does it mean the Fed, is ready to pull the trigger and start to tighten rates?  No. However, versus where the market perceived the Fed to be yesterday, that perception took a turn for the better today. And that is always good news for the dollar.  

 

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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