Fed Chair Janet Yellen walked a fine line in her testimony before the House Financial Committee, a semiannual event that will be repeated before the Senate Banking Committee on Thursday, addressing many of the market’s questions about Fed policy but not committing to any changes. Economists disagreed on what her remarks meant for rate hikes — or cuts — over the next year.
For those wondering whether the Fed would reverse course, undo its December rate hike and possibly adopt negative interest rates like the Bank of Japan and several European banks have, Yellen admitted that “the economic outlook is uncertain … foreign economic developments, in particular, pose risks to U.S. economic growth … [and] “financial conditions in the United States have recently become less supportive of growth.”
But Yellen said she doesn’t expect the Fed will soon be “in the situation where it is necessary to cut rates” and the Fed may not have the legal authority to institute negative rates, though she doesn’t “know of any restriction that prevents us to do that.” Adopting negative rates “remains a question we would need to investigate more thoroughly,” Yellen said, noting that the Fed considered the question In 2010, though not in-depth.
On the flip side, Yellen gave no indication that the Fed was in any rush to raise rates, either, following its December hike — the first hike in years. Yellen repeated her mantra that Fed monetary policy “is not a present course” and will, as usual, take into account changing developments and events. On that score she noted that U.S. labor market conditions “have improved substantially,” though there is still room improvement, while inflation remains below the Fed’s annual 2% target. These are key data points for the Fed’s dual mandate: to promote full employment as well as price stability. Yellen noted the Fed will update its economic projections, including inflation forecast, at its next policymaking meeting in mid-March.
Yellen “tried to walk the line by acknowledging there is increased risk to the U.S. economy presented by global financial markets but she was also careful to indicate that that risk is not overwhelming, says Thomas Simons, money market economist at Jefferies. “The Fed will probably not be raising rates until things calm down, but Yellen said nothing alarmist, nothing about rolling back the normalization process.”
Economist and money manager Gary Shilling read her testimony differently. “Yellen is laying the groundwork for no further rate increases this year and beyond unless labor markets tighten and inflation spurts,” Shilling told ThinkAdvisor. “She’s probably even preparing the markets for a rate cut.” Shilling says there are reasons for such a policy reversal: sluggish GDP growth, near 2%; slack in the labor market despite a 4.9% jobless rate; volatility in global financial markets and inflation well below the Fed’s 2% target. Regarding low inflation, “Yellen blames falling prices of oil and imports, which should end once oil and import prices stop falling, but offers no evidence that they will,” says Shilling.
Financial markets had little reaction to Yellen’s testimony and responses to questions from House committee members, but by day’s end the Dow, which had been trading higher for most of the session, was down almost 100 points. The S&P 500 ended 35 points lower but the Nasdaq was up almost 15 points, and the 10-year Treasury yield fell to 1.7% — its lowest level in a year.
“The market is looking at the Fed having repriced to one or two moves at most this year, maybe none,” says David Kotok, chief investment officer of Cumberland Advisors, referring to rate hikes. “There will be very little additional movement this year, and I didn’t hear Yellen say anything to suggest otherwise.” Yellen had to be “tempered and nuanced,” added Kotok, noting that she “has to stay close” to the statement released after the Fed’s last policy meeting.
Kotok was not impressed by the questions posed by today’s House committee meembers and is looking forward to what Senate Banking Committee members will ask Thursday. “Let’ see what a more adult body does,” says Kotok.
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