Thursday 14 December 2017

Fed's Yellen flags rate hikes on 'meeting-by-meeting' basis

Janet Yellen, chair of the U.S. Federal Reserve
Janet Yellen, chair of the U.S. Federal Reserve

By Howard Schneider and Michael Flaherty

The Federal Reserve is preparing to consider interest rate hikes "on a meeting-by-meeting basis," Fed Chair Janet Yellen told a congressional committee in a subtle change of emphasis in how the US central bank has spoken about its plans for its first rate hike since 2006.

In prepared remarks to the Senate Banking Committee, Yellen described how the Fed's rate-setting policy committee will likely proceed in coming months - an effort to increase the Fed's flexibility and mute any potential market reaction ahead of the "liftoff" date.

The Fed has been criticized for using forward guidance to influence market behavior while at the same time insisting that any rate decision remains dependent on economic data.

The dollar touched a session high after Yellen's testimony started. Short-term rate futures contracts showed traders see a 56 percent chance that the first hike will come in September 2015, based on CME FedWatch, compared with a 54 percent chance prior to the testimony.

Yellen said the policy-setting committee will first drop the word "patient" from its statement, part of a phrase used since December to describe the Fed's approach to the timing of an initial rate hike.

But that is no guarantee rates will be raised at any given point, Yellen said. Rather it will be a signal that the Fed was shifting to a meeting-by-meeting consideration of a hike.

"If economic conditions continue to improve, as the committee anticipates, the committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis," Yellen said.

"Before then, the committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the committee will necessarily increase the target range in a couple of meetings."

Yellen's discussion of forward guidance was part of prepared testimony that included a broad overview of a U.S. economy that appeared to be surging forward with strong job growth and a continued post-financial crisis expansion - conditions largely consistent with a rise in interest rates later this year.

"I would suggest that Yellen is still keeping a very open mind, still in no hurry to give a signal that a rate hike is imminent," said Brian Dolan, head market strategist at New Jersey-based Drivewealth LLC.

LACK OF INFLATION A CONCERN

Alabama Republican Senator Richard Shelby, the chair of the Senate Banking Committee, indicated he was interested in what he considered more fundamental issues such as whether Congress should take a more aggressive role in overseeing the Fed. He has scheduled a separate hearing on that issue next week, and challenged Yellen on the issue in his opening statement.

With a more than $4 trillion balance sheet from its various crisis-fighting efforts, "many question whether the Fed can rein in inflation and avoid destabilizing asset prices," Shelby said. "I am interested to hear whether the current Chair ... believes the Fed should be immune from any reforms."

Yellen's prepared remarks will be followed by a question-and-answer session. On Wednesday she will testify before a House of Representatives committee.

Just completing her first year as Fed chief, Yellen said she felt U.S. labor markets and other key economic indicators "have been increasing at a solid rate." However, she said she still feels the job market is not fully repaired, and that the U.S. outlook remains somewhat clouded by a weaker-than-hoped-for global economy, stalled wage growth, and falling inflation.

None of those factors on their own may be enough to keep the Fed from raising interest rates later this year, perhaps as early as June. Rates have been near zero since the financial crisis hit in 2008, part of a record effort by the central bank to repair the damage of the Great Recession.

But the lack of inflation has made some Fed policymakers hesitant to commit to raising rates until they are more certain the United States is not headed down the same path as Europe or Japan, mature industrial economies that are struggling to maintain growth.

The Fed considers a steady 2 percent annual inflation rate a sign of overall economic health - consistent with its own ability to return interest rates to a normal level, and not so high or low that it distorts household and business spending and investment decisions. Though the current weak prices are considered likely to be a temporary result of the collapse in oil prices, doubts remain.

Yellen's statement could set the stage for the Fed to remove the "patient" reference as soon as its next meeting in March: several policymakers, including some centrists on the committee, have said they feel an interest rate increase should be on the table by June, after the intervening Fed policy meeting in April.

The discussion of forward guidance in Yellen's testimony is an effort to extricate the Fed from a perhaps unforeseen constraint it created when the word "patient" was put in its statement in December. Yellen defined patient as a "couple" of meetings, and policymakers soon became concerned, according to the most recent Fed minutes, that investors would view any removal of "patient" as a sign that interest rates would definitely rise two meetings later.

Reuters

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