Fed’s Yellen Emphasizes ‘Gradual’ Re: Future Rate Hikes

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Increases in the Fed funds rate are likely to be “gradual” in coming years and the current forecasts envisaged by Fed members are just that – forecasts, not the set path for monetary policy, Fed Chairwoman Janet Yellen said in prepared remarks today in New York, largely echoing but somewhat expanding on her observations during the post Federal Open Market Committee (FOMC) press conference March 16.

The gradual increases seen by the Fed “should be understood as a forecast for the trajectory of policy rates that the Committee anticipates will prove to be appropriate to achieve its objectives, conditional on the outlook for real economic activity and inflation,” Yellen told the Economic Club of New York. “Importantly, this forecast is not a plan set in stone that will be carried out regardless of economic developments. Instead, monetary policy will, as always, respond to the economy’s twists and turns.”

Global focus continues. Recalling that earlier this year equity prices were sharply lower, oil was at less than $30 per barrel and many currencies declined in value compared to the US dollar, Yellen said, “Although prices in these markets have since largely returned to where they stood at the start of the year, in other respects economic and financial conditions remain less favorable than they did back at the time of the December FOMC meeting.”

Foreign economic performance is weaker than previously expected and earnings expectations have declined, Yellen noted. “By themselves, these developments would tend to restrain US economic activity. But those effects have been at least partially offset by downward revisions to market expectations for the federal funds rate that in turn have put downward pressure on longer-term interest rates, including mortgage rates, thereby helping to support spending. For these reasons, I anticipate that the overall fallout for the US economy from global market developments since the start of the year will most likely be limited, although this assessment is subject to considerable uncertainty.”

Lessening of headwinds. “Weak foreign activity, dollar appreciation, a pace of household formation that has not kept up with population and income growth and so has depressed homebuilding, and productivity growth that has been running at a slow pace by historical standards since the end of the recession” were all factors cited by Yellen as headwinds for the US economy. “If these headwinds gradually fade as I expect, the neutral federal funds rate will also rise, in which case it will, all else equal, be appropriate to gradually increase the federal funds rate more or less in tandem to achieve our dual objectives. Otherwise, monetary policy would eventually become overly accommodative as the economy strengthened.”

Risks to outlook equal policy caution. The policy adjustments by the FOMC will be cautious ahead, something Yellen said was key as “with the federal funds rate so low, the FOMC’s ability to use conventional monetary policy to respond to economic disturbances is asymmetric. If economic conditions were to strengthen considerably more than currently expected, the FOMC could readily raise its target range for the federal funds rate to stabilize the economy. By contrast, if the expansion was to falter or if inflation was to remain stubbornly low, the FOMC would be able to provide only a modest degree of additional stimulus by cutting the federal funds rate back to near zero.”

Tools available. Should the Fed funds rate return to near zero, Yellen made clear the Fed still has plenty of ammo to use. “In particular, we could use the approaches that we and other central banks successfully employed in the wake of the financial crisis to put additional downward pressure on long-term interest rates and so support the economy--specifically, forward guidance about the future path of the federal funds rate and increases in the size or duration of our holdings of long-term securities,” she detailed. “While these tools may entail some risks and costs that do not apply to the federal funds rate, we used them effectively to strengthen the recovery from the Great Recession, and we would do so again if needed.”

Uncertainty is necessary. Emphasizing the decisions by the Fed remain data driven, Yellen stated, “The future path of the federal funds rate is necessarily uncertain because economic activity and inflation will likely evolve in unexpected ways. For example, no one can be certain about the pace at which economic headwinds will fade.”

Comments: This is an about-as-expected speech from Yellen. The likelihood for a major departure from the stance she took March 16 was minimal ahead of her comments, but note her own observation of uncertainty being necessary. That in itself sums up not only Yellen’s stance but the FOMC situation. They are navigating uncertain waters, navigation that is keeping markets somewhat on edge as they try to determine which course the Fed will plot next. While there are diverging views on the Fed, the views that run counter to the more-dovish stance that won out in the March FOMC meeting are not yet enough to have prompted a shift from Yellen. Given that, it would seem notable too that Yellen did not remind markets that April is a “live” meeting. Her listing of uncertainties probably means that April is not as live as it once was.

NOTE: This column is copyrighted material; therefore reproduction or retransmission is prohibited under U.S. copyright laws.