Federal Reserve Building

Federal Reserve (Fed) Chair Janet Yellen delivered the semiannual Monetary Policy Report to the Senate today (she’ll deliver it to the House tomorrow). When she delivered the report on February 27, 2014, it set off a sell-off in small-cap stocks, as the report called out stretched valuations in small-cap social media and biotech stocks. This year, the report says, “Asset valuation pressures have eased a little, on balance, but continue to be notable in some sectors.” Which sectors are of the most concern to the Fed? It appears as though the Fed is calling out leverage at lower-rated nonfinancial firms and valuation pressures in the commercial real estate market. If there is an area of concern for the Fed, it’s not in equities but in leveraged loans and some areas of the high-yield bond space.

In her prepared testimony, Chair Yellen highlighted how the labor market has improved, but there is still room for improvement. Her wording suggested that she views the remaining weakness as being cyclical, not structural. That’s important because the Fed believes it can do something about cyclical weakness by staying accommodative with monetary policy. There is little the Fed can do to combat structural problems.

When it comes to divining when the Fed may hike rates, she offered a hint by saying, “The Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings.” That means that a rate hike in March or April is out of the picture, though there could be one in June. The key will be whether inflation expectations—as measured by surveys or market-implied rates—come in even further. The recent decline in the market-implied outlook for inflation has been pretty much dismissed by the Fed as being due to less uncertainty around the inflation outlook and not necessarily due to a decline in the rate of inflation. Any further decline in market-implied measures would give the Fed reason to pause on hiking rates.

Whenever the Fed drops the word patience from its policy statement, it could be at any meeting thereafter that it starts hiking rates. This is about as clear as the chair can get in explaining that monetary policy is data, not date, dependent.

Swiss flag

Monetary policy works best (for good or bad) when it is surprising. Doing what’s expected tends not to create waves. So when the Swiss National Bank ended its three-year cap on the Swiss franc-to-euro exchange rate and, in an unrelated move, the Reserve Bank of India cut its target rate by 25 basis points (100 basis points equals 1.00%), they shook markets—perhaps in a good way.

The Swiss central bank decided that it didn’t want to tether its currency to a possibly depreciating currency (namely, the euro). A stronger Swiss franc will initially harm exporters, especially exporters to the eurozone, but it was probably a politically popular move to remove the cap on the franc/euro exchange rate. There have been stirrings about whether the Swiss gave de facto control of its monetary policy over to the European Central Bank (ECB). That is what pegging your currency does: It turns the reins over to someone else. The Swiss were probably a little nervous about importing an expansionary monetary policy if the ECB engages in an expanded asset-purchase program.

For the Reserve Bank of India, low oil prices have filtered into the inflation numbers and have given the bank room to ease monetary policy. The timing of this is fortuitous, as Prime Minister Modi is pushing for further reforms to the Indian economy. Now the central bank and the politicians are basically rowing in the same direction instead of at odds with each other.