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Yellen Raises Odds of a Rate Hike as Early as September

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The odds of a rate hike by the Federal Reserve before December rose Friday morning when Fed Chair Janet Yellen spoke at the annual Jackson Hole, Wyoming, symposium sponsored by the Federal Reserve Bank of Kansas City.

“I believe the case for an increase in the federal funds rate has strengthened in recent months,” said Yellen, citing “continued solid performance of the labor market” and the Fed’s outlook for economic growth and inflation. She added the usual caveat that any rate decision would, of course, depend on the incoming economic data.

U.S. stock and bond markets responded as expected. Stock prices fell, as did bond prices as their yields rose, but the moves were relatively mild. The odds of a Fed rate hike in late September jumped to 33%, double what it was a week ago, according to Bloomberg.

Up until recently, U.S. financial markets were betting on a December Fed rate hike, if any, this year. But in recent weeks, several Fed officials, including New York Fed President William Dudley, Francisco Fed President John Williams and Fed Vice Chair Stanley Fischer, signaled a potential rate hike sooner than December.

Yellen “ took the baton from Bill Dudley and Stanley Fischer and opened the door for a rate hike in the foreseeable future without providing any hint of a specific time frame,” wrote Ward McCarthy, chief financial economist at Jefferies & Co.

Chris Gaffney, president of World Markets at Everbank, isn’t so sure about that. “Ultimately we think Yellen’s speech really doesn’t give us anything new. They continue to be data dependent and the members still ‘believe’ growth will return in the coming months – but the data continue to prove them wrong, so the Fed’s credibility continues to come into question.”

The Commerce Department reported Friday that second-quarter GDP expanded at a 1.1% annual rate, down from the 1.2% it had reported previously.

In her speech at Jackson Hole, Yellen said the Fed expects “moderate growth in real GDP” as well as a stronger labor market and rising inflation (to 2%) over the next few years, which lead the Fed to anticipate “gradual increases in the federal funds rate.”

These are words she has said many times before, but this time she also spoke about the uncertainty concerning the forces that are driving low interest rates here and abroad.

Factors such as smaller productivity gains, slower spending after the financial crisis and slower growth in working-age populations may explain partially why global rates are so low, but, said Yellen, the Fed’s “understanding of the forces driving long-run trends in interest rates is nevertheless limited, and thus all predictions in this area are highly uncertain.”

She said the Fed may need to add some more policy tools to its toolkit to address future economic downturns in addition to the rate cuts, bond purchases, and extended forward guidance it has used before. But she added that even if “average rates remain lower than in the past, monetary policy will, under most conditions, be able to respond effectively.”

Yellen also sald, as she has before, that fiscal policy, too, has an important role to play in addressing economic downturns.

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