Canada constrained until Yellen moves

By Jessica Bruno | October 9, 2013 | Last updated on October 9, 2013
3 min read

As chair of the U.S. Federal Reserve, Janet Yellen wouldn’t change the central bank’s agenda on quantitative easing, jobs or inflation, says BMO senior economist Sal Guatieri.

“It’s business as usual,” he says.

This afternoon, President Barack Obama officially said he’s nominating Yellen to become the chair. If approved by the Senate, she would be the 15th chair of the Fed and the first woman in the role.

It’s expected interest rates won’t initially change under Yellen, Guatieri predicts, and absent significant inflation the Fed’s unlikely to raise rates until the latter half of 2015. This has implications north of the border.

“The Bank of Canada’s hands are pretty well tied by how long it will take before the Fed shifts to a tighter monetary stance,” he notes.

Read: Fed doesn’t taper

If it moves too soon, the Bank of Canada will risk a spike in the value of the dollar, harming trade with America. The move would “weaken the economy meaningfully,” Guatieri explains.

A strong Canadian dollar and weak global demand have caused Canadian exports to stagnate, he adds.

As under Bernanke, economists expect QE to continue until mid-2014 under Yellen.

But the bank will begin tapering as early as mid-December, Guatieri adds.

Minutes released today show the members of the Federal Open Market Committee (FOMC), including Yellen, discussed the issue at their last meeting on Sept. 17 and 18.

All participants except one said the Fed should wait to see more economic data before slowing the rate of federal investment in the markets. The final vote was nine for and one against. The minutes don’t specify who the dissenter was.

Several committee members felt the decision was “a close call,” state the minutes.

Read: News outlets rapped over Fed taper data release

The American interest rate won’t move until the unemployment rate drops to 6.5% or lower, the Fed has stated.

“Our assumption is that Yellen will remain quite pragmatic and will try to achieve both sides of the Fed’s dual mandate: sustain stronger job growth and stable inflation around 2%,” says Guatieri.

Yellen is in favour of inflation targeting that takes into account the general health of the economy, say Scotiabank capital market economists Derek Holt and Dov Zigler.

“In that respect, she is not a radical candidate as some have suggested, but is rather a central banker who adheres to the tenets of all U.S. central bankers, namely, maintaining low and stable inflation and targeting full employment,” write the Scotiabank economists in an investment newsletter released today.

Guatieri notes that becoming chair may make Yellen more centrist, as she’ll have to broker compromises with other FOMC members to set monetary policy.

Read: Should we worry about the next Fed chair?

While Yellen has spoken in favour of controlling unemployment before raising interest rates, she is unlikely to set the target rate any lower than 6.5%, he notes.

“I don’t think the Fed, either under Bernanke or Yellen, will do that unless the economy just fails to pick up in coming months,” he says.

He adds it’s difficult to say how dovish Yellen really is, saying her current stance “may just reflect the current circumstance: the unemployment rate is above its normal level, and inflation is quite low in the U.S., so we don’t know how the new chair will respond when those conditions are not quite as unbalanced as they are now,” he explains.

While Yellen has made a number of speeches as vice-chair, she hasn’t made a public speech since April, note Holt and Zigler.

But she helps set the Fed’s communications strategy, which includes tying action to economic indicators and promising to hold interest rates until a certain date. While she is in favour of more transparent communications, she’s likely already made her changes, say Holt and Zigler. So don’t expect changes to the way the bank explains its decisions.

Read: 9 things to know about Yellen

Before Yellen can become chair, her appointment must first be confirmed by the Senate Banking Committee and then the full Senate. Democrats hold a majority in both arenas.

If she’s approved as expected, she would start her new job Feb. 1, 2014.

Jessica Bruno