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The third broad question: What factors push recovery off the track?

Phalguni Soni

Janet Yellen's speech hints on what the Fed dashboard looks like (Part 5 of 9)

(Continued from Part 4)

On domestic and external factors affecting recovery

Janet Yellen spoke on monetary policy and economic recovery at The Economic Club of New York on Wednesday, April 16. In the last part, we discussed the second of Janet Yellen’s “three broad questions”: Is inflation moving back toward 2%? In this part, we will look at the third question: What factors may push the recovery off-track? The answers to this and the other two questions posed by Yellen are likely to shape future monetary policy.

Janet Yellen cited a few examples of how the recovery over the last five years has been pushed from its planned trajectory:

  • Greater than expected fiscal drag,
  • Sovereign debt crises in some European countries, and
  • Initial assessment of the extent of structural damage to the economy had changed and so did the Fed’s baseline outlook and response in enabling monetary stimulus.

She says that while some forecasts of the unemployment rate falling over the recession have proved accurate, estimates for a falling Fed funds rate have proven to be less accurate. This is because although the economic fundamentals were looking good in April 2010, disappointing growth forced the FOMC not only to keep the base rate low, but embark on a new round of asset purchases of $600 billion, in November 2010. Yellen also makes the point that the falling unemployment rate was enabled by the above-mentioned round of monetary accommodation.

In both 2011 and 2012, weak fundamentals have called for an accommodative policy and the falling unemployment rate has proved that. “I believe that the FOMC’s decision to respond to signs of weakness with significant additional accommodation played an important role in helping to keep the projected labor market recovery on track. These episodes illustrate what I described earlier as a vital aspect of effective monetary policymaking: monitor the economy for signs that events are unfolding in a materially different manner than expected and adjust policy in response in a systematic manner,” said Yellen.

To read about Chicago Fed president and chief executive officer, Charles Evans’ view on accommodative monetary policy, see How the Fed’s monetary policy is still linked to economic recovery.

How monetary stimulus impacts ETF investors

The unprecedented scale of monetary policy accommodation has seen a multi-year bull market run for bond funds (BND) and Treasury (TLT) securities. Further, Treasuries (TLT) have, in terms of fund flows, been the beneficiaries of flight-to-safety trades that tend to result in the event of crises in other countries. For example, the iShares 20+ Year Treasury Bond ETF (TLT) has posted a total return of 29.66% over the past three years.

High yield bond funds like the iBoxx $ High Yield Corporate Bond ETF (HYG) and SPDR Barclays Capital High Yield Bond ETF (JNK) have also benefited from the low interest rate environment, posting total returns of 23.74% and 23.99%, respectively, over the past three years. ETFs such as State Street SPDR S&P 500 ETF (SPY), which track a broad-based stock market index like the S&P 500, have posted a total return of 50.09% over the same period. However, the S&P 500 (SPY) returned over 32% in 2013 alone, its best performance since 1997, with video subscription company, Netflix (NFLX) and semi-conductor maker, Micron Technology (MU), its first and second best performers, up by 297% and 241%, respectively.

Read the next part to know about the Fed’s latest policy on forward guidance.

Continue to Part 6

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