Yellen Speech, Fed Data Send Mixed Messages; What's an Investor to Do?

NEW YORK (TheStreet) -- The economy is booming. The economy is weak. The economy is getting a bit better after a nasty winter, but it's hard to say how fast.

The market heard all three messages yesterday -- all courtesy of the Federal Reserve. So which is it -- and what should investors do about it?

The boom message came from boffo numbers on industrial production, a 0.7% gain in March that handily beat estimates and suggested that manufacturing is surging.

"It ... points to accelerating activity and if that momentum is sustained, we could have a very big second quarter growth rate,'' economist Joel Naroff said.

The "weak" message came from Yellen's speech to the Economic Club of New York, where she repreated her now-familiar refrain that interest rates will stay at near-zero levels until either inflation begins to rise or the last remnants of weakness are out of the labor market.

"A return to full employment is, for the first time since the crisis, in the medium-term outlooks of many forecasters," Yellen said. "It is a reminder of how far we have to go, however, that this long-awaited outcome is projected to be more than two years away."

And the in-between came from the Beige Book, which most pundits depicted as a relatively upbeat look at the economy, courtesy of the central bank's rotating cast of anonymous business contacts scattered across the country.

In fact, it was more mixed than that. About the best the Beige Book said about conditions in any of the 12 central bank districts was that growth was "modest or moderate." In Fed-speak, "modest to moderate" is a step down from "moderate" growth -- which is what nine districts reported as recently as January.

So what does this mean the Fed is going to do?

For now, there was nothing to move the Fed off its current course -- keep reducing its monthly bond purchases that drive down market interest rates, especially on mortgages but keep the Fed funds rate at nearly zero until at least well into next year. The industrial production report tells you that there's no real need for more stimulus, while Yellen's speech makes about as clear as can be that interest rate hikes aren't yet on the horizon.

The question is how long the Fed can keep responding to new, more-positive news like the industrial production report by pointing to real but long-standing problems such as the persistently high rate of long-term unemployment.

For example, Yellen has made a point of arguing that there is little to no pressure on wage growth -- a point she repeated yesterday, and which the Beige Book emphasized, even though the March Beige Book cited a number of cases where wages are beginning to move as unemployment in different regions and different occupations drops.

The New York Times, USA Today and Bloomberg News have all reported that low regional unemployment is beginning to produce higher-than-average wage growth in cities and industries where markets are tighter than the national average.

It's a good time to be job hunting in places such as Silicon Valley, Naples, Fla., and Madison, Wis., and an especially good time to be a construction worker in Dallas. That list will get longer as labor markets tighten.

The usual media potshot after a news day like this is to ding the Fed for hazy communication -- but that's not really fair. The industrial production numbers are what they are -- and can't be cooked. And the sincerity of Yellen's commitment to the 7.4 million people involuntarily working part-time, or the 36% of unemployed people who have been on the street for six months or longer, isn't in doubt.

But the conflict between the Fed's communications and its data underscores that events will overtake Yellen's dovish monetary policy, probably sooner than you think. Remember, just as the Fed is now forecasting that unemployment won't move down much this year, so too did the central bank think in early 2012 that joblessness would stay as high as 8.5% through year-end. When the unemployment rate hit 7.8% in time for the election, we were reminded (again) that even central banks are fallible. 

The next three months will be crucial to determining how long the Fed's historic levels of dovishness can hold out. If -- a big if, given a soft report yesterday on housing starts -- new-home construction bounces back hard in the spring, then most of the economy's major cylinders will be firing. But inflationary pressures should still be modest, especially if employers can offset the impact of slightly higher wages with more productivity growth. That should be easy, since productivity has just posted its worst three-year stretch since the Reagan years. 

If the summer economy produces growth around a 3.5% annual rate, as Naroff expects, by fall the Fed will have a much tougher communications challenge than any it has faced while the economy has been weak. Until now, all stimulus, all the time has been the clear remedy. That will no longer be true: Lower unemployment will be pointing to higher rates, low inflation may seem to allow more stimulus, and wage growth may point to some policy in between. Yellen acknowledged this yesterday, saying that the central bank will need "a more nuanced judgment about when the recovery of the labor market will be materially complete."

Still, the new Fed chair is a beat behind where the economy is, as she sticks up for her kitchen-table constituency. Facts are changing on the ground, and that's going to make the Fed and its new leader show how nimble they can be. And how well they can explain all this new nuance to markets that are still easily rattled.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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