Federal Reserve chief Janet Yellen told Congress Wednesday morning that the balance sheet will shrink "appreciably," but stock indexes surged as she seemed to cede ground to the doves on the softer inflation trend.
Yellen said that the recent decline in core inflation was only "partly the result of a few unusual reductions in certain categories of prices." Previously Yellen had implied that the Fed could overlook lower inflation readings as it continued on its rate-hiking path. In a Q&A, she acknowledged the potential for an"undershooting" of the Fed's 2% inflation target, a signal that future rate hikes will be more data-dependent vs. moving proactively in anticipation of firmer data.
The Fed's Beige Book report, released Wednesday afternoon, didn't suggest the central bank should be in a rush to tighten policy further. The report found "slight to moderate" economic growth across the country, with inflation and wage gains tame.
Yellen's modest shift in tone sent Treasury yields lower Wednesday, while the Dow Jones industrial average rose 0.6% to a record high. The S&P 500 index climbed 0.7% 0.8% while the Nasdaq composite gained 1.1% on the stock market today.
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Bank stocks lagged, including JPMorgan Chase (JPM), Wells Fargo (WFC) and Bank of America (BAC). JPMorgan lost 0.3% and BofA 0.9%, though Wells Fargo rallied to close up 0.2%. Wells and BofA are near buy points.
Any concern that Yellen might deliver a hawkish message seemed to melt away on Tuesday afternoon, after one of the Fed's leading doves, Lael Brainard, stole Yellen's thunder.
Brainard said that she's on board with the Fed's plan to begin normalizing its $4.5 trillion balance sheet. But before the Fed hikes rates again, Brainard wants to implement the change in reinvestment policy and wait for more clarity on the path of core inflation after the disinflationary trend of the past few months.
Yellen is unlikely to seek a fight with the Fed's dovish wing as they wait for clearer signals about inflation. There's no real urgency to do so, with the Fed getting ready to incrementally adjust its current posture of reinvesting all principal from its maturing Treasury and mortgage bonds.
JPMorgan CEO Jamie Dimon said Tuesday that a paring of the balance sheets by the Fed and other central banks could be a "little more disruptive than people think." JPMorgan, Citigroup (C) and Wells Fargo report earnings on Friday, with Bank of America next week.
IBD'S TAKE: IBD changed its market outlook to "uptrend under pressure" on Tuesday, June 27, a signal to investors to exercise extra caution in buying stocks and to take some money off the table to deploy when the turbulence subsides. Make sure to read IBD's The Big Picture each day to get the latest on whether the flashing-yellow market trend turns green.
At the moment, there's a disconnect between the Fed's hawkish signal of four rate hikes over the next 18 months and market pricing for just one hike (in December) through mid-2018, according to CME Group's FedWatch tool.
"In my view, the neutral level of the federal funds rate is likely to remain close to zero in real terms over the medium term. If that is the case, we would not have much more additional work to do on moving to a neutral stance," Brainard said.
Technology stocks have been under pressure the past two weeks as the Fed and European Central Bank both getting ready to reduce the impact of their bond-buying programs.
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