Federal Reserve Chair Janet Yellen gave observers a bit of scare during a speech about policy on Thursday, and (for a change!) it had nothing to do with what she said.
Yellen was visibly ill during her address, frequently pausing, coughing, and even seeming to lose her balance at different junctures. Somewhat abruptly, the Federal Reserve chairwoman cut her speech short, saying, "I think I will end here," out of the blue after about an hour of talking. It was revealed that Ms. Yellen received medical attention backstage after she had finished speaking, and that the cause of her momentary infirmity was a serious bout of dehydration.
Despite feeling sick, Yellen's speech was not without substance, as she played her customary role as market mover by again establishing her expectation that the FOMC will raise interest rates before the 2015 calendar year is out.
Wasn't Yellen a Dove?
The illness aside, Yellen fluffed out her most hawkish feathers for the remarks she gave in front of a crowd of about at UMass, expressing unequivocally that she as well as her colleagues "anticipate that it will likely be appropriate to raise the target range for the federal funds rate sometime this year."
While "sometime this year" may sound a bit vague, it leaves just two options for the Fed to choose from if it is indeed going to raise rates this year: either the October meeting of the FOMC or the committee's meeting in December. The FOMC will not hold a policy meeting in November.
The dollar rose on Friday following widespread media coverage of Yellen's speech. The DXY index rose as high as 96.6 overnight before paring those losses back down to a reading of 96.1. This is oftentimes a harbinger of falling gold prices; spot gold was about $7.50 per ounce lower in Friday trading, falling to $1,147.50/oz.
A rising dollar is seen as a natural and expected consequence of higher interest rates—and the obvious kicker is that the markets react ahead of decisions like moving the federal funds rate, not after. In that sense, market movements gradually become "baked in" to prices and valuations so that, by the time the momentous event of a rate hike actually comes, markets have largely already adjusted.
There are, of course, two other realities about the potential rate hike that challenge this notion of the move being baked in. First is the game of "buy the rumor, sell the news" that the Fed loves to play. (Did anyone else notice how hawkish the various Fed participants' words became just before the committee almost unanimously decided to hold off on raising rates?) Some have called this "flip-flopping," and that's true enough, but it shouldn't be confused for indecisiveness. When the markets follow this well-orchestrated production (rather than reading between the lines to find objective reality), they are prone to ending up on the wrong side of "The Biggest Trade of the Century," as it were.
Second, the federal funds rate is merely a target. A very solid, almost unavoidable target, yes, but non-binding all the same. In a word, it's a benchmark that other banks use. Yet, real interest rates will already be moving higher as the free market dictates it, regardless of what the Fed does. With this in mind, it would seem that the baking in could be happening on the Federal Reserve's side, not the other way around.
We will wait for October to find out.