Fed Sees Fear in Markets, Risks in Economy


The Federal Reserve warned that continued market volatility was threatening America’s economic recovery.  Janet Yellen said before markets opened that the Fed continues to look closely at market volatility and would raise interest rates gradually, with the pace depending on market conditions. Equity futures rose on the news.

Yellen said the Fed’s interest rate path remained “data dependent,” adding that worsening financial sector conditions could result in broader stress throughout the market. "These developments if they prove persistent, could weigh on the outlook for economic activity and the labor market,” she said, adding that foreign risks were also a threat to America’s recovery.

With weak exports to China, lower commodity demand, financial market volatility, and uncertainty over China’s revamped currency policy weighing on foreign markets, Yellen was cautious about the future of American exports. "Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial markets could tighten further,” she said.

Cratering Rates, Inflation Expectations

With indications of weakening industrial output, aggregate demand, price growth, and home buying activity, the market has defied the Federal Reserve and pushed Treasury yields far below their 2015 levels.

The 10-year Treasury was yielding 1.85% after falling from over 3% at the beginning of 2015, with some analysts arguing that yields will fall even further. This is partly the reflection of weakening expectations about inflation, which has fallen from above the Fed’s 2% target and is in danger of falling into deflation.

Nonetheless, Yellen proved resistant to outcries from Wall Street that America’s economy remained weak. "Ongoing employment gains and faster wage growth should support the growth of real incomes and therefore consumer spending,” she said, adding, “global economic growth should pick up over time.”

Her bullish comments included a subtle dismissal of recessionary fears that have clouded equity markets. “[The Fed] expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in coming years and that labor market indicators will continue to strengthen,” she said on Wednesday.

Oil Weakness

While part of the falling inflation is the result of weak demand and stagnant wages, a significant cut in prices has been due to the fall in oil. WTI futures fell to $27.73 per barrel in trading Wednesday, while broad based declines in energy costs have pushed purchasing managers to see continued declines in costs.

The producer price index (PPI) fell in January, according to the ISM, with weak energy costs a significant contributor.

The CEO of British Petroleum, or BP, has warned investors that he remains “very bearish” on oil as he sees storage overcapacity. "In the second half, every tank and swimming pool in the world is going to fill and fundamentals are going to kick in,” said Robert Dudley at the IP Week conference. However, he noted a hint of bullishness by seeing a turn in inventory trends later in the year. "The market will start balancing in the second half of this year,” he added.

Dudley is more bullish about a tightening of supply than Igor Sechin, CEO of Rosneft OJSC, which is the largest Russian oil producer. Sechin predicted a shortfall of 700,000 barrels of oil a day by the end of 2017, but Dudley said BP expects to see inventories decline sooner.