Expectations on the wide – A challenge to Yellen

I wanted to puke this morning reading Janet Yellen’s speech (Zero Hedge link). I’m going to come right out and say what I think. Janet Yellen lied to her audience and lied to the American people today. Her words:

I will make the case that recent developments in commodity prices can be explained largely by rising global demand and disruptions to global supply rather than by Federal Reserve policy.

This is an insane position for Ms. Yellen to take. There at least a dozen separate public statements by Bernanke that the goal of QE is to raise asset prices. Are commodities not assets? They are. And Yellen knows it.

When the Fed has ZIRP, cash seeks out higher risk investments to retain some return. Again, Bernanke and all the other Fed governors have used this line in defense of QE. Ben’s words from just six weeks ago in his “QE is working” speech to the National Press Club:

“Since August, when we announced our policy of reinvesting maturing securities and signaled we were considering more purchases, equity prices have risen significantly.”

Does Ms. Yellen think Americans are stupid? That we don’t understand that monetary policy is a major driver in the economy? That cheap money does create bubbles in things like commodities and equities alike?

If Ms. Yellen is in doubt of that she should sit down with someone who understands the connection full well. I think she should have a tea with former Fed head Paul Volker. He would tell her the same as me. What she is trying to sell is just drivel.

With that off my chest let’s focus on the Fed’s credibility. I want them to be more precise with their definitions of inflation. The Fed is looking at Personal Consumption Expenditures as their definition of a benchmark for  inflation. I maintain that this is a bad matrix as it is backward looking. Inflation is clearly rising. The Fed can’t just look into the rear-view mirror to measure what is going on. They have to be pragmatic and look to the future of inflation as well. There is one measure of future inflationary expectations that is worth noting. The spread between 10-year TIPS and coupons is on the wide. Here’s the graph:

The Fed folks aren’t stupid and they know that inflation expectations drive reality. Yellen said so today:

Critically, so long as longer-run inflation expectations remain stable, the increases seen thus far in commodity prices and headline consumer inflation are not likely to…..warrant any substantial shift in the stance of monetary policy.

Okay. We have her on her word. It is critical that inflationary expectations don’t get out of hand.

So here is my challenge to Ms. Yellen. Give us some firm guidance on expectations of inflation. Use the 10-year TIPS/Coupon spread. When do you get concerned? What ranges do you want? The Chairman has given us firm targets on core (“ a little below 2%”). Give us reasonable ranges on what inflationary expectations the Fed is shooting for.


Ms. Yellen teed this up today. She was the one that said that it was critical to contain expectations. There has been a lot of talk about the Fed communicating its intentions better. This would be a good opportunity. I will send this off to her. I doubt I/we will hear a word. This Fed does not want to look forward. They’re making a mistake. They should all ask Volker his thoughts on this as well.

Note:
In the current environment where we have massive monetary stimulus I think that a 3% spread is coming. At that point the water is already boiling. If the Fed fails to react when markets are ringing alarm bells; they will have made their next historical mistake.