July 16 (Bloomberg) -- Federal Reserve Chair Janet Yellen said stock and bond valuations aren’t out of line with historical norms even as some prices seem on the “high side.”
Yellen told lawmakers in a second day of semi-annual testimony that Fed officials are watching for excessive risk-taking, mindful that holding interest rates low can prompt a “reach for yield.” She said she considers safeguarding financial stability a Fed mandate, reserved the right to aid failing broker-dealers and called a proposal to require the Fed to adopt a rule for monetary policy a “grave mistake.”
“Threats to financial stability are at a moderate level and not a very high level,” Yellen said today. While “some pockets” show “stretched” valuations, traditional gauges “are not outside of historical norms” and there are no “alarming warning signals” across markets, she said.
The Fed chief, in three hours before the House Financial Services Committee, said accommodation is necessary even if it may prompt investors to take on more risk. Yellen said she’s “optimistic about the economy,” while answering questions on topics ranging from bank regulation and mortgage lending to auto sales and industrial output.
“I do think the economy is recovering and that growth is picking up,” Yellen said. “We have sufficient growth to support continued improvement in the labor market.”
The Fed said in a separate report today growth was modest to moderate across all 12 of reserve bank districts amid stronger consumer spending and expanded manufacturing. Labor markets improved with all regions showing “slight to moderate employment growth,” according to the Beige Book business survey based on reports from regional Fed banks.
Yellen’s optimism about the economy and her acknowledgment that recent jobs data is better than the central bank expected suggest Fed officials may tighten policy sooner than they anticipate should economic gains continue, according to Laura Rosner, an economist at BNP Paribas SA in New York and a former researcher at the Federal Reserve Bank of New York.
“She was broadly very optimistic about the economy and the outlook,” Rosner said. “She’s upbeat and sort of signaling that Fed policy is data-dependent, and that given the performance in the economy, Fed policy could be different from what they’re currently envisioning.”
The Standard & Poor’s 500 Index maintained gains after Yellen spoke, rising 0.4 percent to close at 1,981.57 in New York. The yield on the benchmark 10-year Treasury decreased 0.02 percentage point to 2.53 percent.
Even after the Fed ends asset purchases its “sizable holdings of longer-term securities will help maintain accommodative financial conditions, thus supporting further progress in returning employment and inflation to mandate-consistent levels,” Yellen said.
While the central bank is required under the Federal Reserve Act to ensure price stability and full employment, Yellen said she views maintaining financial stability and guarding against crises an “unwritten third mandate.”
Yellen said in response to a question by Representative Scott Garrett, a Republican from New Jersey, that she wouldn’t rule out expanding access to the Fed discount window to broker-dealers and other non-banks during a financial crisis.
“It depends what the circumstances are,” Yellen said. “A broad-based scheme in a situation of systemic risk is a possibility but it is something that would have to be very serious to consider.”
Garrett is sponsoring a bill requiring the Financial Stability Oversight Council to hold open meetings.
When questioned on how the Fed will manage its record $4.38 trillion balance sheet, Yellen referred to exit strategy principles published in 2011 dictating that the size of its portfolio will be “reduced to the smallest levels that would be consistent with the efficient implementation of monetary policy.”
Yellen said the plan is still current and that she expects the Fed will “reiterate an intention over time to reduce the size of our balance sheet” when a revised set of exit strategy principles are made public later this year.
The Fed chief said requiring the central bank to use a formula to set interest rates would be a mistake, because the “short-term scrutiny that would be brought on the Fed in real-time reviews of our policy decisions would essentially undermine central bank independence in the conduct of monetary policy.”
House Republicans have proposed legislation to mandate the Federal Open Market Committee to describe a strategy or rule for how it would adjust interest rates. Currently, the Fed doesn’t bind itself to a formula, preferring flexibility instead.
The bill, which would probably face a challenge in a Senate controlled by Democrats, is sponsored by Garrett and Bill Huizenga of Michigan, a vice chairman of the financial services subcommittee on monetary policy.
In a report accompanying Yellen’s testimony, the Fed also raised concerns over “equity valuations of smaller firms as well as social media and biotechnology firms,” though it said broader equity markets don’t signal too much investor optimism.
To contact the editors responsible for this story: Chris Wellisz at firstname.lastname@example.org James L Tyson, Brendan Murray