YELLEN SPEAKS, DOW FALLS 100: Here's what you need to know

Federal Reserve chair Janet Yellen’s appearance on Capitol Hill on Wednesday was the main event on Wednesday as stocks had a volatile day but ultimately closed little changed though the Dow fell about 100 points.

First, the scoreboard:

  • Dow: 15,913, -100, (-0.6%)
  • S&P 500: 1,852, 0, (-0.03%)
  • Nasdaq: 4,282, +14, (+0.3%)
  • WTI crude oil: $27.40, -2%

Janet Yellen

Federal Reserve chair Janet Yellen is watching the markets. Closely.

Here’s Yellen on Wednesday before the House Financial Services Committee (emphasis ours):

Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar. These developments, if they prove persistent, could weigh on the outlook for economic activity and the labour market, although declines in longer-term interest rates and oil prices provide some offset. Still, ongoing employment gains and faster wage growth should support the growth of real incomes and therefore consumer spending, and global economic growth should pick up over time, supported by highly accommodative monetary policies abroad


As is always the case, the economic outlook is uncertain. Foreign economic developments, in particular, pose risks to U.S. economic growth. Most notably, although recent economic indicators do not suggest a sharp slowdown in Chinese growth, declines in the foreign exchange value of the renminbi have intensified uncertainty about China’s exchange rate policy and the prospects for its economy. This uncertainty led to increased volatility in global financial markets and, against the background of persistent weakness abroad, exacerbated concerns about the outlook for global growth. These growth concerns, along with strong supply conditions and high inventories, contributed to the recent fall in the prices of oil and other commodities. In turn, low commodity prices could trigger financial stresses in commodity-exporting economies, particularly in vulnerable emerging market economies, and for commodity-producing firms in many countries. Should any of these downside risks materialise, foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further.

So we have basically have a two-handed economist. Which you’d expect.

Or as Ian Shepherdson at Pantheon Macroeconomics said, “Overall, though, Dr. Yellen did not sound dovish enough for the doves or hawkish enough for the hawks, so we are inclined to believe her when she says ‘…monetary policy is by no means on a preset course.'”

Neil Dutta at Renaissance Macro said Yellen, “The tone of Yellen’s speech was more dovish relative to the median dot but hawkish relative to the current expectations baked into financial markets … June is likely the earliest the Fed would move rates again.”

And again, stocks were all over the place on Wednesday and didn’t really appear to be taking a sign from Yellen’s commentary, though futures declined modestly after the prepared remarks were released at 8:30 a.m. ET.


The real exciting part of the morning came when Yellen fielded about 2.5 hours of questions from Congress, with the first couple queries wondering why the Federal Reserve pays interest on excess reserves to financial institutions that park money at the Fed.

Yellen’s argument was, basically, that this is how it works.

The Fed targets a Fed Funds range between its reverse repo floor — currently at 0.25% — and its IOER ceiling, which is currently 0.50%.

Yellen noted that while Committee chair Jeb Hensarling (R-Texas) seemed concerned the IOER was basically a subsidy to big banks, these reserves fund the Fed’s balance sheet, which returns an amount far in excess of the reserve interest that is paid out. These returns, which Yellen said total about $600 billion since the beginning of QE, have been returned to Treasury, a win for shareholders, not a subsidy.

Which is one way to see it.&

Negative rates

Yellen was also asked about negative interest rates and whether the Fed believes it has the legal authority to take this IOER rate into negative territory, which would in effect tax the banking system.

It’s unclear.

Yellen told Rep. Patrick McHenry (R-North Carolina):

In the spirit of prudent planning we always try to look at what options we would have available to us either if we needed to tighten policy more rapidly than we expect or the opposite. So we would take a lot at [negative rates]. The legal issues I’m not prepared to tell you have been thoroughly examined at this point. I am not aware of anything that would prevent [the Fed from taking interest rates into negative territory]. But I am saying we have not fully investigated the legal issues.

This line of questioning followed reporting from Bloomberg News’ Matt Boesler that revealed the Fed itself was unsure back in 2010 if it did indeed have the authority to make deposit rates negative.

It appears this hasn’t been clarified.

Of course, were the Fed ever compelled to make interest rates negative in any form or fashion you would imagine that the economic and, by extension, political environment would be quite different either making any legal considerations a non-issue or making negative rates a total non-starter.

So, we’ll cross that bridge when we get there, I guess, but there’s either going to be a bridge or there isn’t.

Kyle Bass

Julia La Roche got her hands on Kyle Bass’ latest letter to investors in which he outlines why he’s loaded up on his bet against the Chinese yuan.

“We have been vigorously studying China over the last year, with the view that the rapid credit expansion in the Chinese banking system will result in significant credit losses that will require the recapitalization of Chinese banks and materially pressure the Chinese currency,” Bass wrote.

Adding, “This outcome will have many near-term and long-term effects on countries and markets around the world. In other words, what happens in China will not stay in China.”

Bass argues that the losses in China’s banking system could exceed 400% of the US banking losses seen during the financial crisis, which seems bad. As it stands right now, Bass already thinks China’s banking system is undercapitalized and challenges the idea that China “has years of reserves to burn through.”

Most of the money in his Hayman Capital funds, La Roche notes, is devoted to his yuan short.

Recession watch

Does the yield curve predict recessions anymore?

Societe Generale isn’t sure.

“Given the yield curve’s many distortions, a number of clients have asked whether it is still a useful recession indicator. Although we see some value in the yield curve’s current message, we agree that its inability to invert under current circumstances makes it an unreliable recession indicator,” wrote Societe Generale’s Aneta Markowska and Subadra Rajappa.

Basically, the central banks ruined this, too.

Traditional economics would say that when you have an inverted yield — that is, when short-term bonds yield a higher rate than long-term bonds — you’re heading towards recession. But with central banks having “distorted” the yield curve, such a clean reading from financial markets is unlikely in the future.

Either way, SocGen sees about a 15% chance of recession in the next year.

Meanwhile, Scott Brown at Raymond James outlined how a spooked consumer can make a US recession a self-fulfilling prophecy.

The basic idea is that if consumers sense the labour market is slowing they will hoard cash while corporates that see stock prices call could halt spending bringing economic activity to a halt. It’s a pretty standard view on how financial markets can cause real-economy stress, but it’s a view at least.


Shares of Disney fell almost 4% on Wednesday after the company reported earnings and revenue that beat expectations though earnings from its cable networks segment fell 5% due to struggles at ESPN.

In a note to clients following the report Ben Swinburne at Morgan Stanley said pressure on ESPN’s subscriber base remains a concerns, writing, “While Disney noted a recent increase in ESPN subs, we continued to believe ~2% annual sub losses are a good base case.”

And while it may be the case that specific concerns about ESPN are being overplayed in the market, it seems like there’s no good pure play way to short the sports-industrial-complex, which just sort of feels too big.

Take Bob Iger’s conference call comments for example (emphasis ours):

So I actually believe — and I know you want to know about the floors in terms of our agreements — but I actually believe that this notion that either the expanded basic bundle is experiencing its demise or that ESPN is cratering in any way from a sub perspective is just ridiculous. Sports is too popular. And it’s not just at ESPN. Look at how the Super Bowl did, as a for-instance which I realise is a penultimate event, but day after day, week after week, month after month, year after year, live sports ends up being among the highest rated programs across television. And ESPN has this incredible, as you know, incredible set of licence agreements with all the major sports. It’s got the best menu of live sports that is out there.

All of this is true but is sports going to be the biggest thing for all time? Who knows. If you don’t think so, betting against Disney is at least one way to do it.

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