The stock market reversed an early loss and moved steadily higher in the morning as Yellen, President Barack Obama’s nominee to head the Federal Reserve, testified at her Capitol Hill confirmation hearing. Monitoring her poised performance from desks around the world, traders concluded that she would stick with policies that have sent shares soaring. The Standard & Poor’s 500-stock index closed at yet another nominal high Thursday, up 25.6 per cent this year.
Despite the run-up, Yellen also said she did not believe that the trillions in stimulus money the Fed has injected into the financial system since the near collapse of the global economy had created a bubble, another very good sign of her supportive views as far as Wall Street is concerned.
“Stock prices have risen pretty robustly,” she said, but at current valuations, “you would not see stock prices in territory that suggests bubble-like conditions.”
Some Republicans on the committee did not take such a sanguine view.
Noting the market’s current level, Senator Mike Johanns, R-Neb, said, “I think the economy has gotten used to the sugar you’ve put out there, and I just worry that we’re on a sugar high.”
Senator Patrick J Toomey, R-Pa, used a more seamy metaphor.
“What happens when this morphine drip starts to end?” he asked.
While there is considerable debate about just how much of the rally can be attributed to Fed policies, there is no doubt that Wall Street wants to see it continue. When Ben S Bernanke, the outgoing chairman of the Fed, hinted in the spring that $85 billion in monthly purchases of Treasury securities and mortgage-backed bonds might soon be scaled back, stocks promptly plunged.
Since mid-September, when Bernanke and Fed policymakers surprised Wall Street by not beginning the taper, stocks have surged once again. By taking a more accommodative, or dovish, stance on monetary policy and focusing on the need to bring unemployment down, Yellen essentially is saying the Fed will not take its foot off the gas until it believes the economy can race ahead on its own.
More hawkish policymakers and some senators worried, however, that a highly accommodative policy had spurred excessive risk-taking as money managers reach for yield, or borrow at low interest rates to bid up stocks and other assets.
Going into Thursday’s hearing, some traders feared Yellen would take a slightly more cautious stance, said
Tobias Levkovich, chief US equity strategist at Citi. But she did not do anything of the kind, Levkovich said.
Nerves are on edge, too, because many fund managers are sitting on big gains for the year and they do not want to see anything disrupt that, or cost them their bonuses.
“The focus isn’t about long-term investing,” Levkovich said. “It’s about making your year. And she provided a continued feeling that there is no liquidity door being slammed in their faces.”
Yellen’s position on the stock market also created some unusual ideological alignments Thursday.
Historically, the GOP has been considered sympathetic to Wall Street, but several Republicans, including Johanns and Toomey, criticized the Fed for propping the market up.
Yellen, a Democratic appointee who is considered dovish on monetary policy, was in the position of essentially saying the stock market is fine and not to worry.
She did not provide unconditional support, though. In an exchange with Senator Bob Corker, R-Tenn, Yellen said she would not hesitate to prick a bubble if it did develop – a view that puts her somewhat at odds with her two most immediate predecessors, Bernanke and Alan Greenspan – and would use the Fed’s regulatory powers to police the banks as well, to avert a repeat of 2008.
“No one who lived through that financial crisis would ever want to risk another one,” she said.
To be sure, even if the Federal Reserve does begin tapering as soon as its next meeting in December, or more likely waits until early 2014, there are signs Wall Street might not react as negatively as it did in the spring.
For one thing, last week’s better-than-expected data on economic growth and job creation have raised hopes that the government shutdown in October did not do much harm to the economy. And the expansion might pick up speed next year. Moreover, Yellen suggested Thursday that other elements of monetary policy would remain accommodative as well, even if the monthly bond purchases were pared back.
For example, the Fed has said that short-term interest rates will remain near zero at least until unemployment, now at 7.3 per cent, fell to 6.5 per cent. Many economists, like Jan Hatzius of Goldman Sachs, now expect the Fed to lower its threshold to 6 percent, meaning rock-bottom rates are likely to continue at least into 2016.
“There’s a sense she’s putting even more focus on labour markets,” Levkovich said. “All that’s good for a near-term stimulus.”