Sentieo is now part of the AlphaSense family. Read the Announcement

Why Is The Fed Still Raising Rates? The Yellen Effect

This article was originally published in Forbes

Our second investigation of the Fed’s sentiment discusses the impact Chairwoman Yellen has had on the Federal Reserve since her rise to the Chair in 2014. We created and utilized our ‘FedSpeak’ lexicon to delve into the correlation between the Fed’s intentions and Yellen’s speeches before colleagues, Congress, and the press. Read the previous article and see what’s coming up next in our series here:

Sentiment Analysis Of FOMC Statements Reveals A More Hawkish Fed
Why Is The Fed Still Raising Rates? The Yellen Effect
Assessing Fed Chair Hopefuls With NLP Analysis Of Past Speeches
Predicting The FOMC Statement With Beige Book Sentiment Data

The Federal Reserve conducts the nation’s monetary policy under a mandate from Congress to promote maximum employment, stable prices, and moderate long-term interest rates in the U.S. economy.

The Fed began its current round of rate hikes in 2015, and the Fed Funds target rate now stands at 1.25%, up from 0% two years ago.

The Federal Open Market Committee (FOMC) judges that inflation at the rate of 2 percent (as measured by the annual change in the price index for personal consumption expenditures, or PCE) is most consistent over the longer run with the Federal Reserve’s mandate.

Inflation (PCE), Unemployment, and the Fed Funds rate

Since the Fed began the most recent rate tightening cycle, the PCE has fallen from just under 2% to 1.3%. If we consider a policy lag of 6 to 9 months for Fed hikes to feed their way into the broader economy, it would appear that the early hikes in 2016 have had their desired impact on inflation, and with the most recent tick up in the unemployment rate, one would think the Fed would stop hiking now.

And yet the CME’s Fed Funds futures market is pricing in a greater than 70% chance of another hike in 2017, with two more hikes to follow in 2018.

We used Sentieo and natural language processing of public Federal Reserve documents to figure out why.

If actual inflation is falling, perhaps the Fed is worried about inflation expectations. However, Google searches for “inflation” have remained relatively stable over the past 10 years within a normal seasonal band. By contrast,  “unemployment” searches look to be bottoming out of a long downtrend.

At the corporate level, using the Sentieo Document Search and Plotter functions, we can see that conference call transcript mentions of words relating to “pricing power” and “price increases” remain at a fairly stable level, if perhaps a modest uptrend, but still without any prominent increase in the expectation of pricing power or inflation.

Business TV news analysis shows only a modest increase in stories about inflation since 2016.

Mentions of inflation across major cable business news networks has not risen over the past year and a half

And NY Times business articles also show only a slight decrease in mentions of inflation.

NY Times Business news articles mentioning inflation

So why is the Fed still expected to hike rates?

The simple reason, we discovered, is that Fed Chair Janet Yellen is hawkish by nature.

We developed our own lexicon, the Sentieo “FedSpeak” lexicon, and analysed seven years’ of Fed Chair speeches to Congress from 2010 to the present day with a text mining algorithm. We specifically focused on the adjectives used around the word “inflation.”  

Janet Yellen took the helm of the Fed on February 1st, 2014, and gave her first testimony to Congress later that month. Looking at the average sentiment of her speeches versus those of her predecessor Ben Bernanke, there’s a clear break in tone upon her arrival as Fed Chair.

Yellen is definitively more hawkish when compared with Bernanke in her own speeches, but the minutes mute that impact with the other FOMC members

By contrast, there was much less of a noticeable change in tone of the FOMC meeting minutes, which includes discussions by all members of the FOMC, not just the Chair.

The Chair exercises the final authority over what the Fed ultimately does as laid out in the FOMC Statement published immediately upon conclusion of the meeting.  These statements, too, showed a significant “Yellen Effect.”

And, starting in 2011, the Fed Chair began sitting for press conferences following FOMC meetings.  Here, too, there’s a clear change in tone between the two Fed Chairs.

And yet the Fed hasn’t changed its hawkish tone, as we showed in our previous article on the Fed.

The Fed probably would have already halted its tightening cycle, given the increased negative sentiment of its communications, the recent drop in PCE, and a modest reversal in unemployment trends of late. But the “Yellen Effect” is keeping the hikes on. In our next article, we’ll analyze past speeches given by frontrunners in the race to replace Janet Yellen at the helm of the Fed when her term expires in February 2018 to see if we’ll get a hawk or a dove next.