Fed’s Yellen Still Sees Gradual Rate Rises, But Offers No Timeline

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Despite outlining risks to the US economy and labeling the June 3 May Employment report as “disappointing,” Fed Chairwoman Janet Yellen said she still expects gradual increases in the Fed funds rate but she stopped short of putting any timeline on an upward adjustment in interest rates.

“An important theme of my remarks today will be the inevitable uncertainty surrounding the outlook for the economy,” Yellen told the World Affairs Council of Philadelphia. “Economic developments abroad have significantly restrained growth in the United States over the past year, although I am cautiously optimistic that these headwinds are now fading.”

China and commodity price worries eased. “Concerns about slowing growth in China and falling commodity prices, which afflicted global financial markets early this year and thus likely weighed on demand, appear to have eased somewhat,” Yellen observed. “Indicators suggest that foreign economies are growing, if still at only a moderate pace, and foreign financial markets have recovered and stabilized.” However, Yellen pointed to net exports, stating they have been a “drag” on the US economy over the past year “and are likely to continue to weigh on growth over the medium term. This drag, in part, reflects the prolonged effects of the significant increase in the foreign exchange value of the dollar since the middle of 2014, a development that has been particularly challenging for US manufacturers and other firms competing with foreign producers.”

Lower oil prices double-edged sword. While lower oil prices have been a “positive” for the US economy overall, Yellen cautioned that due to a sizable US energy industry, “they have had a negative side.” The scaled-back oil drilling operations have spilled into other areas of the sector. However, Yellen observed the largest declines in drilling activity are likely now behind us, and with oil prices having recovered somewhat, I expect that oil prices will become less of a factor.”

Uncertainties remain. The uncertainties for the US economy “are sizable,” Yellen observed, “and progress toward our goals and, by implication, the appropriate stance of monetary policy will depend on how these uncertainties evolve. Indeed, the policy path that my colleagues and I judge most likely to achieve and maintain maximum employment and price stability has evolved and will continue to evolve in response to developments that alter our economic outlook and the associated risks to that outlook.”

Jobs data ‘concerning.’ While stressing that one should not attach too much importance on one month’s data, Yellen said the report was “on balance, concerning.” However, she also pointed to other indicators from the jobs sector that are more positive -- the number of people filing new claims for unemployment insurance... remains quite low, and the public’s perceptions of the health of the labor market, as reported in various consumer surveys, remain positive.” Still, given the outsized importance of the jobs report, Yellen stated the Fed “will need to watch labor market developments carefully.”

Inflation progress still not as strong. Inflation has “run persistently below the Fed’s goal of 2% over the past several years even as the labor market strengthened significantly,” Yellen noted. “Over the 12 months through April, the price index for personal consumption expenditures rose only about 1%. But I remain optimistic, because two factors that have been holding down inflation will likely prove only temporary.” Those factors include crude oil and strength in the US dollar, Yellen said. “As the downward pressure on prices from these two forces dissipates and as the labor market strengthens further, I expect inflation to move back to 2%,” Yellen said.

Optimism on updated Fed projections. FOMC members on June 15 will release new projections on the US economy. “Those could, of course, differ from the previous set of such projections in March,” Yellen commented. “But speaking for myself, although the economy recently has been affected by a mix of countervailing forces, I see good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones. As a result, I expect the economic expansion to continue, with the labor market improving further and GDP growing moderately. And as I just noted, I expect to see inflation moving up to 2% over the next couple of years.”

Expect surprises. Discussing what Yellen labeled “considerable uncertainty” on the economic outlook, she reminded that “we should expect to be surprised in the future just as we have been surprised in the past.”

Four key areas of uncertainty. Domestic demand remains one, Yellen said, noting a key question is “whether the US economy could continue to make progress amid fairly considerable global bumpiness. I continue to think that the answer to that question is yes, but the weak investment performance in recent months is concerning, and Friday’s employment report provides another reminder that the question is still relevant.”

The economic situation outside the US is the second uncertainty, Yellen said, noting that while risks have eased, “global risks require continued attention. Much of the turmoil early this year appeared to be associated with concern over the outlook for Chinese growth, which in turn has broad implications for commodity prices and global economic growth. Recently, the renminbi has moved in a more predictable fashion and Chinese capital outflows have abated. However, it is widely acknowledged that China faces considerable challenges as it continues to rebalance its economy toward domestic demand and consumption.”

Productivity growth in the US is a third key, Yellen observed. “While the job market has strengthened significantly, GDP increases have been less impressive,” she detailed. “That combination of solid labor market gains and moderate GDP growth reflects the fact that labor productivity growth has been unusually weak in recent years, averaging less than 1/2% per year since 2010.”

How quickly inflation moves back to the Fed’s 2% goal is the fourth uncertainty, Yellen said. “As long as oil prices do not resume their earlier declines and the dollar does not rise substantially further, my expectation is that inflation will move up to 2% over the next one to two years.” However, those two could still thwart progress toward the Fed’s goal. But oil prices and the dollar can move unpredictably. In addition, a further strengthening of labor market conditions would typically be estimated to exert modest upward pressure on inflation over the next couple of years; but such estimates are inherently imprecise, and the effect on inflation could turn out to be significantly different, either upward or downward, than I expect.

Rate rises will be appropriate, but no timing offered. Yellen said she still thinks the Fed funds rate “will probably need to rise gradually over time to ensure price stability and maximum sustainable employment in the longer run.”

Limited tools if inflation doesn’t respond. While noting the Fed could move quickly if inflation were to best the Fed’s 2% goal or the economy were to become “overheated,” Yellen said, “if inflation were to remain persistently low or the expansion were to falter, the FOMC would be able to provide only a limited amount of additional stimulus through conventional means.”

Stronger labor market and progress to inflation goal are keys. “I continue to believe that it will be appropriate to gradually reduce the degree of monetary policy accommodation, provided that labor market conditions strengthen further and inflation continues to make progress toward our 2% objective,” Yellen stated. “Because monetary policy affects the economy with a lag, steps to withdraw this monetary accommodation ought to be initiated before the FOMC’s goals are fully reached.” Weaker growth early this year prompted the Fed to keep their policy stance steady, Yellen said. “Over the past few months, financial conditions have recovered significantly and many of the risks from abroad have diminished, although some risks remain. In addition, consumer spending appears to have rebounded, providing some reassurance that overall growth has indeed picked up as expected.”

But the May jobs data is a potential concern, Yellen acknowledged, one that the FOMC “will be wrestling with these and other related questions going forward.”

Comments: This does not sound like a Fed chief that is ready to raise the range for the Fed funds rate at the June meeting. He listing of caution areas for the economy and leaving plenty of caveats on economic growth contribute to that conclusion and then there is the May Employment report that Yellen herself labeled “disappointing.” Given that there are no more job updates ahead of the June meeting, this is what the Fed has to go on at this stage. Yellen also did not give any signals about the number of rate increases envisioned by the Fed for the remainder of this year. In the question and answer portion, Yellen reminded that the Fed has to constantly rethink their policy situation and that also allowed her to stress that monetary policy is not a preset course and sounds like a Fed that really means “gradual” when they say it relative to the pace of rate increases ahead.

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