Yellen Voices Economic Optimism as Fed Begins Gradual Tightening

Fed Liftoff Highlights U.S. Economy's Strength
  • Fed chair says `myth' economic expansions must die of old age
  • Stock market rallies as Yellen highlights economy's strength

Federal Reserve Chair Janet Yellen delivered a two-pronged message that stock market investors cheered: The U.S. economy is performing well and the central bank is in no rush to raise interest rates again.

QuickTake The Fed Lifts Off

She told a news conference that the central bank had put itself in a position to nurture the 6 1/2-year-old expansion by raising rates a bit now to avoid having to increase them a lot later. That will enable the Fed to tighten policy gradually, moving rates up in fits and starts to keep the economy on track.

While U.S. exports had been hurt by weaker overseas growth and a stronger dollar, Yellen said these headwinds were being offset by a solid expansion in domestic spending.

"Americans should realize that the Fed’s decision today reflects our confidence in the U.S. economy," Yellen said. "While things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement."

Equity prices rallied in response, with the Standard & Poor’s 500 Index of U.S. stocks rising 1.5 percent to 2,073.07 in New York. Bond prices fell on the prospects of higher short-term interest rates, though yields on the benchmark 10-year Treasury note remained below levels seen last month.

‘True Leadership’

“She has managed to pull it all together,” said Chris Rupkey, chief financial economist with Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “Speaking out to the American public and telling them with a first rate hike that the economy is on the path to sustainable improvement is a move that shows true leadership.”

Wednesday’s quarter-point increase in borrowing costs was the culmination of a year-long effort by the Fed to prepare investors, consumers and companies for the end of an unprecedented era of ultra-easy money.

The Federal Open Market Committee lowered its benchmark rate to zero to 0.25 percent in December 2008, three months after the collapse of investment bank Lehman Brothers Holdings Inc. and 10 months before unemployment in the U.S. peaked at 10 percent.

“The first move is very significant," Richard Davis, chief executive officer of U.S. Bancorp, the nation’s largest regional bank, said in an interview. “It gives everyone permission to agree that we are now moving forward with the recovery."

Confident Outlook

Yellen repeatedly stressed her confidence in the health of the U.S. economy and played down concerns that it would be knocked off course by weakness overseas or by the recent tumult in the high-yield bond market.

Since the recovery began in June 2009, gross domestic product has grown at a steady, albeit unspectacular, pace of 2.2 percent per quarter on average. The expansion has already lasted longer than the post-World War II mean of just under five years.

"It’s a myth that expansions die of old age," Yellen said. "I don’t see anything in the underlying strength of the economy that would lead me to be concerned" about a recession.

She acknowledged in response to a question that central banks in the past have killed off expansions by tightening policy. But she argued that was because policy makers felt compelled to raise rates sharply and abruptly because they had waited too long to move.

"It is because we don’t want to cause a recession through that type of dynamic at some future date that it is prudent to begin early and gradually," she said.

Yellen used the word "gradually" or "gradual" about a dozen times in her hour-long press conference to describe the pace of future rate increases.

Policy makers forecast that the short-term policy rate will rise to 1.375 percent at the end of 2016, implying four quarter-point increases in the target range next year, based on the median number from 17 officials.

"I do want to emphasize that while we have said gradual, gradual does not mean mechanical -- evenly timed, equally sized, interest-rate changes," she said. "As the outlook evolves, we’ll respond appropriately. I strongly doubt that it will mean equally spaced hikes," she added.

The Fed will be able to take such an approach because inflation is so far below its 2 percent goal. As measured by the personal consumption expenditure price index, it rose by 0.2 percent in the 12 months through October.

Yellen repeatedly argued that inflation was largely being held down by transitory forces -- weaker oil prices and a stronger dollar -- and that it would begin to rise as those influences waned and the jobs market continued to strengthen.

Inflation Evidence

She did though suggest that policy makers would want to see signs of that happening as the central bank proceeds along a path of higher interest rates.

"We really need to monitor over time actual inflation performance to make sure that it is conforming, it is evolving in the manner that we expect," she said.

That would help buttress inflation expectations, which have recently shown signs of softening. Yellen has stressed the importance of keeping such expectations anchored in order to ensure the Fed is able to hit its inflation target.

"We’ve said that if there is one metric to watch it’s going to be inflation, and based on her comments, that was accurate," said Curt Long, chief economist at the Arlington, Virginia-based National Association of Federal Credit Unions. "The question on everyone’s mind is, at what point are we going to have to see actual inflation as opposed to believing it’s right around corner."

The decision by the FOMC to raise rates for the first time since 2006 was unanimous. The move drew to a close an unprecedented period of record-low rates that were part of extraordinary and controversial Fed policies designed to stimulate the U.S. economy in the wake of the most devastating financial crisis since the Great Depression.

"The economic recovery has clearly come a long way, although it is not yet complete," Yellen said. The Fed rate increase "reflects the committee’s confidence that the economy will continue to strengthen."

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