US Interest Rates

Yellen cautious on low inflation as Fed plots rate rises

Treasury yields slide as central bank head acknowledges uncertainty

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JULY 12, 2017 by: Sam Fleming in Washington

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Janet Yellen acknowledged on Wednesday that the US’s persistently subdued inflation could raise questions about the Federal Reserve’s current path of gradually raising interest rates and vowed to watch prices “very closely” for signs they were stagnating.

The Fed chair insisted it was “premature” to second guess policymakers’ determination inflation was slowly headed to the central bank’s target of 2 per cent. But her note of caution helped spark a rally in US Treasuries and equities, with investors hopeful Ms Yellen would keep the Fed’s easy money stance for longer.

The S&P 500 rose 0.7 per cent and the Dow Jones Industrial Average closed at a new record high, while the yield on the benchmark 10-year Treasury slid 4 basis points to 2.32 per cent.

Ms Yellen was broadly positive about the economy’s recent performance in testimony to Congress, stressing there had been a rebound in household spending over recent months and the Fed was still anticipating further rate increases.

But she also said she was studying the low inflation numbers for signs that short-term drags on prices may not be the only factors holding it back. She added that rates may not need to be lifted a lot more to get back to a neutral stance.

“We are watching inflation very carefully,” Ms Yellen said in response to questioning from lawmakers. “I do believe part of the weakness in inflation reflects transitory factors, but well recognise that inflation has been running under our 2 per cent objective, that there could be more going on there.”

Analysts said Ms Yellen’s remarks marked a small but significant change of thinking, putting the Fed’s path of gradually pulling back on economic stimulus in question.

“Yellen’s statement today reveals that the Fed isn’t as sure about inflation as they led us to believe,” said Luke Bartholomew, investment strategist at Aberdeen Asset Management. 

There is . . . uncertainty about when — and how much — inflation will respond to tightening resource utilisation

Janet Yellen, Federal Reserve chair

Emerging markets, which depend on money flows from low-yielding rich countries, were particularly heartened by Ms Yellen’s remarks. The South African rand, the Turkish lira and the Russian rouble led a rally of emerging market currencies, with the rand jumping over 2 per cent.

“The market interpreted remarks from Yellen on inflation as a signal that the Fed is unlikely to accelerate the pace of tightening, which is an encouraging signal for the high yielding EM currencies,” said Piotr Matys, EM forex analyst at Rabobank.

The Fed exited the latest policy meeting with policymakers divided over how to respond to disappointing inflation readings. Core inflation, measured by the Fed’s preferred gauge, retreated slightly to 1.4 per cent in May, defying predictions from some rate-setters that price growth will be buoyed by America’s robust jobs recovery.

While only one rate-setting official — Neel Kashkari of the Minneapolis Fed — dissented over the Fed’s quarter-point rate increase in June, persistently poor inflation numbers could yet embolden doves at the central bank in the coming months.

For her part, Ms Yellen has repeatedly argued during the Fed’s rate-raising cycle that inflation will eventually materialise given the continued improvements in the jobs market, and she stuck firmly to this view on Wednesday.

The US economy at a glance
The FT’s one-stop overview of key US economic data and trends

In her testimony, Ms Yellen continued to ascribe the poor readings in part to “a few unusual reductions” in a handful of items in the inflation basket. But she also acknowledged that other factors may also be weighing on price growth.

Stronger growth of incomes and jobs should “increase resource utilisation somewhat further, thereby fostering a stronger pace of wage and price increases,” Ms Yellen argued. 

However, she added: “Of course, considerable uncertainty always attends the economic outlook. There is, for example, uncertainty about when — and how much — inflation will respond to tightening resource utilisation.”

Ms Yellen added that rates would not have to rise very much to get to a neutral stance. Over the longer term the rate that is needed to keep the economy on an even keel was likely to increase, meaning “additional gradual hikes are likely to be appropriate over the next few years”.

Federal Reserve’s Brainard sees low cap on interest rates
Policymaker also says US central bank can start reducing its balance sheet ‘soon’


She signalled that the Fed’s plans to start unwinding the stock of quantitative easing it amassed during the crisis were on target, and expressed confidence that the process should not roil markets. Ms Yellen reiterated that the balance sheet move could come “relatively soon” but she emphasised that the exact timing does not matter a great deal.

Hanging over the hearing was the possibility that Ms Yellen may be making one of her last appearances before Congress. She repeatedly faced questions probing whether she wanted a second term if it was offered by Donald Trump, and said only that it was something she would discuss with the president if it came up.

However when asked if this might be her last testimony before the House committee Ms Yellen acknowledged that this was possible.

Ahead of her possible departure, the Fed has been pushing to retain broad discretion over monetary policy in the face of a campaign by Republican lawmakers to push it to a more rules-based system.

In her remarks, Ms Yellen stressed the hazards of an over-reliance on policy rules to guide rate-setting.

While the Fed regularly consults the rules, “such prescriptions cannot be applied in a mechanical way”, Ms Yellen says in her testimony. “Their use requires careful judgments about the choices and measurement of the inputs into these rules, as well as the implications of the many considerations these rules do not take into account.”

Some Republicans are hoping to see a future chair who is willing to place a higher priority on rules, such as those recommended by Stanford professor John Taylor, to set rates.

Randal Quarles, whom Mr Trump this week nominated to the Fed’s Board of Governors, has expressed support for a more formulaic approach to rate-setting. Marvin Goodfriend, another possible nominee, has as well.

Additional reporting by Adam Samson in New York

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Mike Jul 27, 2017

Hmmm, inflation is getting softer. Who could have predicted that! :-o

And guess what: it's going to get softer...

Now, the only thing that will mediate falling inflation is the weaker dollar. But, short of a crash in the USD, it won't be enough to offset the disruptive cost savings being caused by technology.

This is the first time that the Fed has said that falling inflation may be systemic - and not a one off.

Well done Fed, nice of you to catch up: shame about your policy response. Tightening is not what you do in the face of falling inflation. The text books say that FOR A REASON!

Voice of Truth Jul 13, 2017

Why doesn't the yapping yellen admit that she is clueless and depending on the markets and goldman to tell her what to do? Totally pathetic. There is no way that she will be re-appointed unless Trump admits to his membership in the financial mafia. 

Pat Mcgavock Jul 13, 2017

I have yet to see a photo of Yelllen that doesn't resemble a deer staring into headlights. Apt, really.

Muppet Jul 12, 2017

inflation would follow if they raised rates

of course it doesn't say that in the books

1) people start asking for a rise (labour's quite tight);

2) businesses have to get productive; 

3) consumers have to start buying before it goes up; 

4) banks get sweet margins for lending; 

4) dollar's up, imports are cheaper softening some of the pain (and exporting some inflation elsewhere); 

5) asset prices top out and decline 

6) and there's a normality dividend as well as relief that we don't all have to worry endlessly about when rates will rise because it's already happening so that-paradoxically consumers have more confidence to spend than the books say

7) savers are in the money and start to spend

but no..... it's not in the books

follow the books and turn Japanese


Sound of the Suburbs Jul 12, 2017

"Yellen caution on low inflation as Fed plots rate rises”

The FED should try plotting the private debt to GDP ratio, they will see things like 1929, the S&L crisis and 2008 as they are building up.

Currently they keep getting surprised when it all blows up.

Janet “Look for when the gradient gets steeper, unproductive private debt is rapidly building in the economy”.

Danmalin Jul 12, 2017

The headline is wrong...treasuries rallied i.e. yields fell.

BajanBoy Jul 12, 2017

Until they get short rates back to about 3% every hike is an 'ease' not a tightening.... this is a lesson that seems impossible for economists to learn... all (literally all) evidence to the contrary.

untaladro Jul 12, 2017

@BajanBoy And where did you get this magical number from?

BajanBoy Jul 12, 2017

@untaladro From Seven Faces of the 'Peril'... but not interpreting the data the same way Bullard did... It isnt really all that magical.

seafoid Jul 12, 2017

It is like the emperor's new clothes. With the GOP as a lunatic colony.

the Taylor rule won't work given the quantum of debt

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