Yellen Signals Fed’s Patience With Zero Interest Rate Has Limits

U.S. Fed Chair Janet Yellen
Janet Yellen, chair of the U.S. Federal Reserve, speaks during a Senate Banking Committee hearing in Washington, D.C. Photographer: Andrew Harrer/Bloomberg

Federal Reserve Chair Janet Yellen signaled that the central bank’s patience with holding interest rates near zero has its limits as she began laying the groundwork for a possible increase in borrowing costs later this year.

While she made clear no rate increase is imminent, she told the Senate Banking Committee that the economy is on solid ground and she saw hints wages may be starting to pick up. Although inflation is still too low for the Fed’s liking, she ascribed its recent softness mainly to lower oil prices and said central bankers expect it to rise gradually to its 2 percent target in the medium term.

“She opened the door for rate increases in the second half of the year,” said Michael Gapen, chief U.S. economist at Barclays Plc in New York and a former Fed official.

The clearest sign of that shift came with Yellen’s suggestion that the central bank might drop its pledge to be “patient” in deciding when to begin tightening credit. That promise, which was reiterated by policy makers last month, meant that a rate increase was unlikely for “at least the next couple” of meetings, she said.

A modification of that pledge -- which Gapen said could occur next month -- wouldn’t lock the Fed into an immediate rate rise, Yellen said. Instead, it would be a signal that liftoff “could be warranted at any meeting.”

Stock and bond prices climbed after Yellen downplayed the possibility of an immediate rate increase. The Standard & Poor’s 500 Index rose 0.3 percent to a record 2,115.48 at 4 p.m. in New York. Ten-year Treasury yields dropped eight basis points, or 0.08 percentage point, to 1.98 percent.

Market ‘Relief’

“There’s a bit of a relief trade here that she wasn’t hawkish,” said Michael Materasso, who helps oversee $348.3 billion of bonds as co-chairman of the fixed-income policy committee at Franklin Templeton Investments in New York.

Yellen’s remarks are in keeping with her effort to move away from calendar-based guidance on monetary policy, instead conditioning investors to watch the data as they seek to judge when borrowing costs are likely to rise. Most Fed officials have predicted an increase at some point this year.

“They are seeking flexibility,” said Roberto Perli, a former Fed official who is now a partner in Washington for Cornerstone Macro LLC. “They want to be data dependent and move away from strong forward guidance.”

Fed officials had voiced concern that abandoning their pledge to be patient on rates could cause turbulence in financial markets. Investor response to her testimony should help allay those worries, economists said.

Tightening Speed

Sarah House, an economist at Wells Fargo Securities LLC in Charlotte, North Carolina, said Yellen offered no clue about more important questions such as how fast and how far rates will be raised after liftoff takes place. Perli added that the pace of Fed tightening could end up unsettling markets if it proves to be faster than investors expect, which he suspects will be the case.

Yellen, who is scheduled to testify to the House Financial Services Committee on Wednesday, struck an upbeat note in her assessment of the economy, saying the job market is improving and household finances are in better shape. While growth will probably slow from its 3.75 percent annual pace in the second half of last year, it will still be strong enough to keep reducing joblessness, she said.

“There is reason, I think, to feel good about the economic outlook,” Yellen said, noting that the expansion has proven sturdy enough to withstand a lagging housing market and weak growth overseas.

Stronger Hiring

A bright spot has been the labor market. Payrolls rose 257,000 in January, capping the greatest three-month jobs gain in 17 years. Wages registered their biggest increase since 2008, according to data from the Labor Department in Washington.

Falling oil prices are also “a significant overall plus” for the economy, Yellen said. Gasoline prices reached an almost six-year low of $2.03 a gallon in January compared with last year’s peak of $3.70.

The lower energy prices also are dragging inflation further below the Fed’s 2 percent target. The Fed chief said the central bank expects inflation “to decline further in the near term” before rising gradually back to the central bank’s goal.

As measured by the personal consumption expenditure price index, inflation was just 0.7 percent in December.

Questions from senators at the hearing ranged from financial regulation to increased lawmaker oversight of the central bank.

Audit Bill

Yellen strongly criticized a proposal to allow congressional audits of the Fed’s monetary policy, saying it would curtail central bank independence and expose it to political meddling.

“Audit the Fed is a bill that would politicize monetary policy, would bring short-term political pressures to bear on the Fed,” the Fed chair said. She added that such a law isn’t needed because the Fed already is “extensively audited.”

On monetary policy, Yellen faced pressure from Republicans, including Pat Toomey of Pennsylvania, to raise rates above zero, while Democrats, including New York’s Charles Schumer, focused on the need to keep policy easy.

She sought middle ground in response, saying a premature rate increase could undermine the recovery, while the Fed must also be cognizant of the risks of waiting too long.

With the labor market expected to continue to improve, the Fed’s decision on when to go ahead with its first rate increase will hinge on what happens with inflation, said Ward McCarthy, chief financial economist at Jefferies LLC in New York.

Yellen has said the central bank will need to be “reasonably confident” that inflation is rising back to its goal before starting to raise rates.

“She has given them a whole lot of flexibility,” said McCarthy, who doesn’t see the Fed moving on rates until December.

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