All Eyes on Yellen

All eyes will be on Janet Yellen tomorrow, when she speaks at the Fed's annual economic symposium in Jackson Hole. Fed Chair speeches at this particular conference always garners a lot of attention, so I thought it'd be a good example to share a thought experiment: If you knew whether Yellen's speech was going to be hawkish or dovish, do you know how the US Treasury market would react? Or any other market for that matter?

My guess is that even if Yellen lays out a radical new policy (unlikely), nobody knows what it will mean for markets. Any headlines written tomorrow (and they will invariably look like this (just circle what happens): Yields/stocks rise/fall, as Yellen signals tightening/easing) will simply be ex-post rationalizations of the price action. Consider the following unexpected and disparate scenarios following past Fed actions:

Rates fall when the Fed tightens:

During the last couple of economic expansions, Fed hiking cycles were met with falling longer-term rates. It occurred in the mid-90s, then again a decade later, and now another decade later today.  Remember that momentous rate hike last December, the first after seven years of zero interest rate policy (ZIRP)? What happened to Treasury bonds? The benchmark 10-year Treasury yield has fallen about .75% since then. The price action did not match the consensus understanding of the yield curve. It confused Greenspan, who gave a famous speech describing the "conundrum." Some may say, "Yes, but rates would be going up except for European and Japanese monetary policies." Perhaps, but this rebuttal is actually an admission that short-term rates do not control long-term rates.

Rates rise when the Fed tightens:

Of course, the opposite is true as well. Both Bernanke and Yellen have made off-hand comments during press conferences that suggested tightening and yields spiked. In 2013, Bernanke discussed tapering asset purchases and set off the now famous "taper tantrum." 

If you knew what Yellen would say:

If Yellen's speech is dovish, will that raise inflation expectations QE-style (bond prices down) or cause more concern about growth prospects (bond prices up)? Even if you knew what Yellen is going to say, you do not know how Treasuries will react, much less various other markets.

Alternatively, if Yellen's speech is hawkish, will the market face a Greenspan-era conundrum or a Bernanke-era "Taper Tantrum?" Nobody knows and the result may change over time. Rates could spike at speech time, fall over the following week, rise until year end, or any number of random combinations.

I think rates could go up a lot, but I'm not predicting that. They could drop to zero or below and I would not be too surprised either. My allocations are designed to weather a variety of scenarios, so I do not have a horse in this race or desire to convince anyone that if x, then y. My only point in this post the thought exercise to demonstrate that maybe nobody else knows either. 

To paraphrase Twain, "It's not the things you don't know that get you in trouble, its the things that you know for certain that just ain't true."