Developments in the Greek crisis justifiably diverted attention from Federal Reserve Chair Janet Yellen’s semi-annual testimony to Congress last week.
Most of the coverage tended to focus on Yellen’s valiant efforts to parry attacks on the autonomy and accountability of the central bank (past, present and future). Yet the Fed chief also provided important insights about the future of interest rate policy:
1. Timing: Based on what she knows today, Yellen is inclined to initiate the Fed’s hiking cycle this year, and perhaps as early as September. Instead of waiting until 2016, when she might have to raise interest rates more aggressively, she would rather lead a gentle campaign of increases that starts this year and proceeds gradually, as new economic data warrants.
2. Rationale: Although wage growth remains too muted, Yellen anticipates the labor market will strengthen further, carried by robust job creation. Combined with moderate growth in domestic demand, the brighter employment picture is expected to underpin the continued rebound from disappointing first-quarter growth.
3. Not just cyclical: Yellen seems to be warming to the notion that the U.S. economy faces more than cyclical headwinds. By taking into account the role of structural issues, including moderate productivity growth and sluggish supply responsiveness, she can be less worried about inflation persistently undershooting the Fed’s objective.
4. International context: Although the Greek crisis is of concern, Yellen doesn’t believe that its effects are limited to the downside. She also sees upside risk for Europe.