Yellen Signals End of Zero-Rate Patience With Flexible Timetable

Updated on
Janet Yellen Speaks: Senate Testimony in Two Minutes

Federal Reserve Chair Janet Yellen sought to prepare investors for a change in the Fed’s pledge to be “patient” on raising interest rates, saying it would provide flexibility to tighten when conditions are ripe.

A shift in guidance would signal the economy has improved to the point where an increase “could be warranted at any meeting,” while not necessarily committing policy makers to a rate increase on a specific timetable, Yellen said in testimony Tuesday before the Senate Banking Committee.

Yellen struck an upbeat note in her assessment of the economy, saying the job market is improving and household finances are stronger. Stocks and Treasuries initially fell, then rallied as investors focused on her comments that inflation and wage growth remain too low.

Yellen’s remarks are in keeping with her efforts to move away from calendar-based guidance, instead conditioning investors to watch the data as they seek to judge when borrowing costs are likely to rise for the first time since 2006. Most Fed officials have predicted an increase some time this year.

“The Fed is pushing to get flexibility,” said Diane Swonk, chief economist at Mesirow Financial Holdings Inc. in Chicago. “They want to move away from the concept that guidance is a pledge on policy.”

The Standard & Poor’s 500 Index rose 0.2 percent to 2,114.61 as of 1:35 p.m. in New York. Ten-year Treasury yields fell seven basis points, or 0.07 percentage point, to 1.99 percent.

Couple of Meetings

Yellen Tuesday repeated that the Fed’s pledge to be “patient” on beginning to raise the benchmark interest rate means an increase is unlikely for “at least the next couple” of meetings. The central bank adopted the guidance in December and repeated it in January.

Michael Feroli, chief U.S. economist, at JPMorgan Chase & Co. in New York, predicted the Fed will change the guidance at its next meeting, in March. “And between March and June, and then September, it’s going to be the data” that determines when rates rise, he said.

Questions from senators ranged from financial regulation to the state of the housing market. 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.

“There’s a huge danger that what the Fed has done could end very badly,” Toomey said. “We could probably do a better job maximizing employment and economic growth if the Fed focused on price stability.”

Middle Ground

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

“Before raising rates, we will want to feel confident that the recovery will continue and that inflation is moving up over time,” she said. “There are also, of course, risks of waiting too long to remove accommodation. We have a highly accommodative policy that’s been in place for some time. We have to be forward looking.”

Yellen also 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,” Yellen said. She added that such a law isn’t needed because the Fed already is “extensively audited.”

Wage Growth

Fed policy makers are trying to judge whether the labor market has improved enough to warrant raising interest rates in coming months, even as inflation remains well below their 2 percent goal.

A market-based measure Tuesday put the odds of a June liftoff at around 19 percent, based on futures and options trading data compiled by Bloomberg. This compares with odds of around 25 percent before publication last week of minutes of the Jan. 27-28 meeting, which surprised many investors by showing that many officials were inclined to hold rates near zero for a longer time.

Yellen repeated that the FOMC, before raising rates, will want to be “reasonably confident” that inflation will move back up to the central bank’s goal. Its preferred gauge of inflation, the personal consumption expenditures index, has stayed below 2 percent since April 2012, and it rose just 0.7 percent in the year through December.

Oil Prices

She also restated the committee’s view that the recent drop in inflation was principally due to oil’s plunge.

“The committee expects inflation to decline further in the near term before rising gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate,” she said.

The U.S. economic picture has brightened in recent months, encouraging the Fed to end its program of buying bonds in October in a first step in tightening policy.

In the seven months through January, employers added more than 1.9 million workers to non-farm payrolls, helping to reduce the jobless rate to 5.7 percent. The economy recovered from a first-quarter slump to expand at a 2.4 percent pace in 2014, the most since 2010.

Bubble Danger

Some of Yellen’s colleagues on the rate-setting Federal Open Market Committee have argued the bank should already be raising rates in order to head off a potential jump in inflation or the emergence of destabilizing financial bubbles.

Yellen pointed to risks to the U.S. from abroad, citing “disappointing foreign growth and changes in monetary policy abroad” as reasons longer-term interest rates falling “significantly” since mid-2014 in the U.S. and other advanced economies.

Slowing across foreign economies “could pose risks to the outlook for U.S. economic growth” and despite slight pickups in the second half of last year, Yellen said other nations “are confronting a number of challenges that could restrain economic activity.”

Yellen said China, the world’s second-largest economy, “could slow more than anticipated” as policy makers work to reduce risk in financial markets and rely less on exports, while euro area still faces slow growth and low inflation.

Still, she cited a potential boost from other central banks adding stimulus. “We could see economic activity respond to the policy stimulus now being provided by foreign central banks more strongly than we currently anticipate, and the recent decline in world oil prices could boost overall global economic growth more than we expect,” Yellen said.

Before it's here, it's on the Bloomberg Terminal. LEARN MORE