'Whatever, Janet' Indeed -- Fed's Yellen Outfoxes the Bond Bullies, Finesses Rate Policy, Buoys Investors

03/23/2015 12:50 pm ET | Updated May 23, 2015

U.S. financial markets have been highly volatile but with little to show for investors, as opposed to traders, who make their best livings from pointless volatility, for all the swaying back and forth since the start of 2015.

We all know the basic economic facts: U.S. gross domestic product was down into the low 2% range for the 4th quarter of 2014 as compared with the robust 5% gain in the 3rd quarter; the U.S. dollar's recent, almost parabolic 17% gain against the Euro was causing major American multinational corporations, dependent on foreign sales, to lower their projections for 2015 revenue and earnings. This, in turn, led to reduced expectations for first quarter 2015 GDP: oil was falling with the dollar's rise (it's priced in dollars) and the positive aspect for U.S. consumers of lower gas prices seemed to be muted by their enhanced saving rates and cautious post-Christmas spending. Retail sales into the new year were weaker than expected (probably also affected to some degree by the bad February weather); so were housing starts and sales (probably for the same reason). Meanwhile, the European Central Bank was initiating its own quantitative easing program to stimulate the flaccid European economy and reverse a trend toward actual deflation, while the U.S. Federal Reserve seemed to be on an opposite course of action -- raising interest rates -- by middle of the year, as job growth continued at a fast, 295,000 net positive growth trajectory, even in cold, snowy February.

These frustrating and somewhat conflicting facts led many investors to sell first and ask questions later as markets reacted with 1% or more multiple daily loses, interspersed with occasional equivalent one-day (but never two-day) gains if there was any hint of bad economic news to push against the perceived headlong direction of the Fed to raise rates no matter what the dollar's fall or oil's fall or the Euro's fall was doing to both U.S. and overseas economic growth prospects. The financial markets were positioned so that any economic "good news" (like the February jobs data and lower unemployment rate) was perceived as "bad news" for stocks and bonds because it would lead the Fed to raise rates prematurely.

Where did the notion that the Fed would supposedly raise rates during a "soft patch" in the economy come from? The focus began in earnest after the Fed's January 28 meeting when the Fed refused to remove the word "patient" from its statement describing its stance regarding the process of beginning to lift its benchmark interest rates for the first time since 2008. That word "patient" was understood by the markets, based on previous statements by Fed Chair Janet Yellen, to mean that no increase would be initiated at its next two meetings: i.e., not in March or April. But inferentially, that language also opened the door to a rate hike at its mid-June meeting, which many in the markets felt would be too soon based on the softening GDP and retail data despite continued job strength (albeit without the wage growth the Fed said it was looking for).

Investor fears were increased when commentators first read the January statement to suggest a rate hike in June, while major investment banking firms like Goldman Sachs and Morgan Stanley cautioned against any rate rise before the autumn or even at all until 2016 because of weakening world economic conditions and major deflationary trends offsetting the positive effect of more hiring in the U.S. Meanwhile, as noted in a prior blog post, CNBC's Rick Santelli and his guests were continuing to attempt to bully Chair Yellen and other Fed members into raising interest rates immediately in order to satisfy the economic notions of options and futures traders in Chicago frustrated by the "artificial" pricing of risk they saw as a result of the Fed's stimulus policies (not to mention the reduction in their trading income). The situation was not clarified for investors when a non-voting Fed Regional Bank President, James Bullard of St. Louis, seemed to agree with Santelli to some extent when he urged the Fed to remove the "patient" language (and thus its effective two-meeting hold on rate increases) in its March statement to pave the way for a rate increase move in June (with the added support of some voting members like President Williams of the San Francisco Fed).

Even Chair Yellen, who never gets ahead of herself or her Committee colleagues in Congressional testimony, conceded to senators that the word "patient" could be dropped in March (but that such a move would not automatically mean a June rate increase). Markets were left to speculate and consensus quickly drove to a certain expectation of an end to "patience" and a move toward a summer rate hike despite the soft data -- with many viewing this as a mistake as evidenced by eight days of triple digit moves in the Dow before the Fed's March 18 meeting. Just before the meeting, such diverse market participants as Christiane LeGarde, head of the International Monetary Fund, and Ray Dallio, a major hedge fund player, both warned against the Fed repeating its 1937 mistake of raising rates too quickly as a recovery was just taking hold, and the dire consequences of such an error for the rest of the world as well as the U.S..

Fed "whisperer" (or, more precisely, "whisperee" ) Jon Hilsenrath of the Wall Street Journal summarized the contours of the "box" the Fed found itself in with respect to market expectations; the Fed wants "wiggle room" to act on the basis of incoming data, not tied to a fixed schedule, and doesn't want to either surprise the markets or necessarily telegraph its timing by continued "forward guidance" like a two-meeting window.

Market commentators got busy in the days before the March meeting predicting an investor "panic" if the "patient" word were to be eliminated (much like the "taper tantrum" of late spring and summer 2013), to the delight of short-seller hedge funds. Scared investors followed suit with several triple-digit down days.

But Janet Yellen outfoxed them all. She engineered a unanimous Fed statement that both eliminated the "patient" language and also stressed that the Fed was indeed mindful of the softer economic data and would wait to see if inflation data actually made a higher turn and labor market slack actually tightened along with job growth before raising rates! The markets didn't panic; the Dow jumped nearly 400 points from bottom to top. She also held master class press conference to follow up where she summarized the whole new scenario in a very investor-friendly phrase: "just because we have removed the word "patient" from the statement doesn't mean we're going to be impatient." The Chair knows how to turn a phrase to advantage - and the market held its gains into the close.

Unfortunately, there is no hyperlink as yet to Rick Santelli's hyperbolic post-Fed meeting, anti-Yellen rant on CNBC (which was typically busy promoting him for Fed Chair earlier in the day). But watch for it on your favorite website. It was a doozy.


Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.