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Janet Yellen's got some explaining to do

Byron Wien: I no longer expect a Q1 rate hike

Federal Reserve Chair Janet Yellen has a few fences to mend.

That's because the normally chummy relationship the U.S. central bank has with Wall Street hit a bump last week when minutes from the Open Market Committee's most recent meeting left room for confusion about the Fed's path forward.

Where the market thought the FOMC was getting confident enough in the economy to move forward with a steady stream of small interest rate increases, the minutes indicated a jittery bunch of central bankers. They worried at the January meeting that it might be too soon to start raising rates, fretted over upsetting the market by removing the word "patient" from the post-meeting communique and generally conveyed an air of hesitation over how to unwind the Fed's mammoth balance sheet.

Consequently, Yellen's got some work to do in conveying certainty to the Street. She'll get her first chance Tuesday, which marks the start of two days when she'll address Congress in her semiannual briefing sometimes referred to as the Humphrey-Hawkins hearings.

The remarks will give her a chance to undo some of the damage from the release of the minutes and help give the market a better handle on the pace of rate increases. The Fed is widely expected this year to lift its target fund rates from near zero, but how it will do so remains a mystery. Initial reaction after the meeting had futures bets leaning toward a September hike or later, compared to previous expectations of a June move.

"A mixed and muddled message" was how Michael Hanson, an economist at Bank of America Merrill Lynch, described the January meeting deliberations.

Janet Yellen, Chair of the Federal Reserve.
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"The minutes were sufficiently muddled that a June rate hike still remains on the table, although the risks toward our September expectation (or later) have inched up," Hanson said in a note to clients. "It's now up to Chair Yellen in her upcoming congressional testimony to clarify how the Fed is currently leaning."

In terms of language, the market focused on two passages from the minutes: One referred to "many participants" concluding that current conditions "had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time." The other part in question dealt with members' worries over removing the word "patient" from the attitude toward raising rates, with a notation that doing so was "risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates."

"From our perspective there is hardly a better way to 'guide' the market toward the reality of an imminent rate hike," complained Tom Porcelli, chief U.S. economist at RBC Capital Markets. "So, yes, removing 'patient' would be suggestive of an imminent rate hike. But this is much more prudent than continuing to promote data dependency without providing the yardstick."

Porcelli believes that if the misgivings from the minutes are reflected in Yellen's testimony, then "June will have to be rethought" as a target for the first rate increase.

"Given the continued strong inclination of several members on both sides of the dove/hawk spectrum in stating quite plainly that midyear seems reasonable, we find the lack of cohesion in this messaging vexing (that's the polite way of describing our feelings)," he added.

If the first rate increase does get pushed back, investors are unlikely to get upset. After all, it's been the Fed's largess through monthly asset purchases—discontinued in October—and zero interest rates—in place for more than six years—that have helped propel stocks to a more than 200 percent gain since the March 2009 lows.

What the market does want, though, is some sense of certainty.

"The minutes suggest that officials are looking at some form of alternative guidance that would stress the data dependence of the timing of the first rate hike instead," Paul Ashworth, chief U.S. economist at Capital Economics, said in a report for clients. "The problem is that the Fed has only been able to qualify very vaguely what improvement in the data it is looking for."

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Congress likely will push for Yellen to give more clarity.

Ashworth, whose firm had been expecting a rate hike as early as March but has since pushed that back, said the market will be watching closely.

"It will be interesting to hear what (Yellen) has to say in her semiannual monetary policy testimony," he said. "For now, we still expect the Fed to drop 'patient' in March and to begin hiking rates in June."