Janet Yellen Sticks to the Script (Here’s What It Means for Investors)
Janet Yellen made her debut before Congress today as the new head of the Fed…
And just like they did for her predecessors, the markets hung on every single word.
Except in this case, nobody (and I mean nobody) expected any major fireworks. What they were looking for instead was a confirmation that it would be “business as usual.”
Judging by the nearly 200 point jump in the DOW that followed, I’m guessing that nobody walked away disappointed.
In her prepared comments, Yellen provided no surprises as it relates to the Fed’s exit plan for its quantitative easing “tapering” plans. The immediate impact of which has been a lengthening of the yield curve.
That means, barring anything unforeseen, there will be continuity rather than change. Nonetheless, it does raise some major points that will have a direct bearing in the energy sector.
Here’s what it all means for investors…
What Janet Yellen Won’t Tolerate
First up, as yields continue to rise, pressure is emerging on the price side of the bond-trading picture. Essentially this translates into an inverted debt market, with some medium-term inflationary consequences.
Now, inflation is the one consequence that the Fed will simply not tolerate.
Therefore, as I have noted before, there will need to be some attention directed toward the price side of the equation. For the new Fed chief, that may mean some tinkering with the tapering mechanism.
The balance between price and yield will be critical here.
And as we begin to move into the next round of a major expansion in unconventional oil and gas production in the U.S., the ability to float debt to pay for significant new infrastructure development and refurbishment will be decisive.
In this arena, interest rates will be key since the debt markets are going to play a major role in financing that expansion.
Second, we’ll once again be focused on the unemployment figures. Like her predecessors, Ben Bernanke and Alan Greenspan, Yellen will view the employment level as the thumbnail indicator of where the economy is going, just as inflation will be regarded as the principal bogeyman.
Yet it is true, of course, that the longer these stats are the primary concern of monetary policy, the less likely we are to actually zero in on the most compelling factors contributing to the economic expansion.
That is because employment is almost always the last of the primary indicators to rise once an economic recovery is underway. On the other hand, it is also usually shorthand for a range of political issues more related to elections rather than genuine prosperity.
In addition, these unemployment figures actually tell us less about what is really going on. As more workers drop out of the market, and as those removed from the unemployment compensation lists continue to increase, the real unemployment rate becomes less a function of the stats and more a result of partisan political perceptions.
What’s more, the primary impact these figures have on energy forecasts remains one of the thinnest connections ever devised. Even still, we continue to see knee jerk reactions to employment figures due to their perceived impact on energy demand.
Now admittedly, a major economic recession would have a chilling effect on the need for energy, and that would kick in across the board. But we are nowhere close to another recession.
And in actuality, as I have pointed out on several occasions, it is not even U.S. demand levels that determine energy pricing.
Prices are set in other areas of the globe, in developing rather than mature industrialized countries.
Where the Demand Can Really Be Found
In these “up-and-coming” economies, the demand expectations are rising again – and it’s for the full-range of both conventional and renewable/alternative sources. Once again, the reality of the situation is buried beneath the hype of talking heads on TV.
Take the Chinese figures, for example.
While it is true that energy demand in China is a driving force and that demand is connected to industrial and commercial expansion, what the “analysts” have done to that connection is nothing short of a travesty.
In fact, I marvel at how these guys can wring their hands on camera whenever it looks like China is “slowing down.” Sorry, but how a 7% increase in overall demand and a likely spike in energy requirements can be considered a harbinger of tough times totally escapes me.
The impact all of this angst has had on the Chinese solar market is a good current case in point.
Today, worldwide solar prospects are increasingly centered on China – both because the next generation of advances is going to come from there and because major providers elsewhere are being acquired by Chinese interests.
Now, there was no doubt that the solar market became overheated and a correction was in order. But to listen to what is coming from the supposed experts, it sounds like Armageddon. It makes me think these misfits are actually shorting these shares on the side (or at least putting in their short orders immediately after leaving the studio).
Let’s put these matters in perspective.
In truth, the U.S. Federal Reserve has a very limited direct impact on demand levels that exist elsewhere.
And while the prospects for a demand-employment relationship may have some effect, that dynamic is not going to be a decisive indicator on global trends coming from the U.S. or Western European economies.
The balance between American pricing and yield levels may have some correlation, but only to the extent that foreign market moves requires access to U.S. debt.
Janet Yellen’s Primary Role
The much longer-term consequence of a debt bubble in the states on dollar-denominated assets globally is another matter. Yet that is a multi-year result (read, paralleling 2007-2012).
And we have no indications of another one of those coming down the pike.
In any event, a focus on employment prospects has just about the least pivotal consequence for realistic energy demand levels. There are simply too many intermediary variables. Once again, a crash has more direct results across the spectrum. But we have no indication this is coming even on the horizon.
Finally, the Fed does have a primary role to play and that is found in determining the relative cost of money. This remains its primary monetary policy function and the essential reason the Federal Reserve System was established to begin with.
However, unlike the artificial stimulus packages encompassed by the quantitative easing for which tapering is now the reverse, the effective cost of money is a market function, with rates largely determined in regard to inflationary pressures.
Much of what the energy sector will need in the short run is serviced quite well by this traditional option.
Which is only to say that, as long as Janet Yellen sticks to the script, the energy sector will do just fine.
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