Yellen Dip Bought, Bulls Buoyed By Fed’s Focus On Labor Market

The focus away from inflation allows the Fed to solely focus on jobs and continue with its accommodative policy. The fed funds rate – the conventional tool – is already zero-bound, hence the use of unconventional tools.

In the last 14 months, the central bank’s balance sheet has gone up by $3.57 trillion to $7.81 trillion. That is a lot of liquidity sloshing around in the system. It has to go somewhere. The pace of increase has obviously moderated versus a year ago but the four-week change is solidly positive (Chart 5).

Amidst this came April’s employment report, which kind of vindicated the Fed last Friday. The economy only produced much-weaker-than-expected 266,000 non-farm jobs, bringing the monthly average this year to 451,000.

At 144.3 million, non-farm jobs are still 8.2 million short of the pre-pandemic record high of 152.5 million jobs reached in February last year. The unemployment rate similarly was 3.5 percent – the lowest since May 1969 – back then, versus 6.1 percent in April (this year).

If the Fed is determined to get to the levels before the pandemic sent in, there is a lot of catching up to do. The only question is, in its quest to do so, will it also have released the inflation genie out of the bottle? The short end of the curve is not worried about these prospects, not to mention equities, which seem to be benefiting from a ‘heads I win tails you lose’ phenomenon. If last Friday’s jobs report met expectations, it would be viewed as one more data point symbolizing that the recovery was firmly in place. Now that the report disappointed, it is used to argue the Fed would continue to stay easy.

Yellen could be right in the long run – or not. Time will tell. But, right here and now, until the short end of the market begins to rebel, the Fed is set to turn a blind eye to inflationary pressures. April’s jobs numbers just made sure of that.

VIX probably sensed these dynamics last week and suffered a mini breakdown. On April 14, the volatility index posted an intraday low of 15.38 before turning higher. A rising trend line drawn from that low was breached on Friday (Chart 7).

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