Yellen Claim Fed Isn't Behind Curve Challenged by Robust Hiring

  • Fed running accomodative policy ahead of likely fiscal boost
  • Investors on alert for possible faster rate increases

Doth the lady protest too much?

Twice in the past three months, Federal Reserve Chair Janet Yellen has made a point of insisting that the Federal Open Market Committee has not been too slow in raising interest rates.

“Recently, Fed speakers have been rhetorically asking whether the FOMC is behind the curve,” Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, said in a recent note to clients. “While they consistently answer in the negative, the very fact they are asking the question may belie the doubts in their own heads.”

As the Fed prepares to meet next week to consider an interest-rate increase that investors view as a certainty, a small but growing number of economists are wondering whether the central bank has been tardy in tightening its stance. While some of them have been cautioning about lax monetary policy for a while, the warnings have taken on fresh relevance following an employment report that was strong across the board.

Payrolls grew 235,000 in February, well above the 75,000 to 125,000 monthly pace that Yellen has said is sustainable in the long-run. Joblessness dipped to 4.7 percent, in line with most officials’ estimate of what constitutes full employment. And wage growth accelerated, with average hourly earnings registering a year-on-year gain of 2.8 percent.

Policy makers penciled in three quarter percentage-point rate increases for 2017, according to the median projection in forecasts released in December. Investors are on alert for a bump up in that forecast when officials release new forecasts on March 15.

Inflation Goal

The argument that the Fed has been too slow off the mark starts with the low level of the benchmark federal funds rate that the central bank targets. At 0.5 percent to 0.75 percent, the target range is markedly below the 1.7 percent core inflation rate. And it’s at that depressed level just as the Fed is closing in on its objectives of maximum employment and 2 percent inflation -- a fact that officials themselves acknowledge.

“We’re very close to achieving our dual mandate goals,” San Francisco Fed President John Williams said on Feb. 28 in Santa Cruz, California. “Yet monetary policy essentially still has the pedal to the metal, with interest rates that remain near historical lows.”

With just two rate increases since the recession’s end in 2009, the Fed is running what Yellen says is a “moderately accommodative” policy ahead of what could be a shot of fiscal stimulus from President Donald Trump and a Republican-controlled Congress.

“One of the problems of being so far behind the curve, is that if this fiscal legislation passes and you get stronger growth, the markets are going to be very sensitive to any signs of inflation,” said Mickey Levy, chief economist for the Americas and Asia at Berenberg Capital Markets LLC in New York.

The combination of a budgetary boost and monetary accommodation will raise inflation to close to 3 percent in two years’ time, according to Mark Zandi, chief economist at Moody’s Analytics.

Run It Hot

That may be by design, he said, noting that Yellen may have opted to run the economy a bit hot to draw more Americans into the workforce.

A big problem confronting the Fed chair and her colleagues is how little economists seem to know about the inflation process. It didn’t collapse into deflation when unemployment surged to 10 percent in 2009, nor has it picked up much since as joblessness has declined.

Yellen herself has said “it’s unclear” how much of a direct effect wage increases have on inflation.

“What we’ve found is that in a situation where labor and product markets are tight, inflation tends to move up,” she told the Senate Banking Committee on Feb. 14. “And movements in wage growth gives us a sense of just how tight labor markets are.”

In a speech in January, Yellen described wage growth as subdued, though modestly higher than it had been. She also pointed to spare capacity in the manufacturing industry as another sign that the economy wasn’t overheating.

It’s rising asset, not consumer, prices that concerns economist Joe Carson as they lift household net worth. That’s what led to the last two recessions, with the peaking of the Dot-com share price boom in 2000 and the bursting of the housing market bubble in 2007.

A few Fed officials are worried as well, according to the minutes of their Jan. 31-Feb. 1 meeting.

They voiced concern that investors were pinning their hopes on a more expansionary fiscal policy that might not materialize and were not taking full account of how uncertain the outlook was.

“The Fed has to put some risk back into investing,” said Carson, director of global economic research at AllianceBernstein LP in New York.

Instead, central bankers seem to be going out of their way to avoid spooking investors by repeatedly insisting that the central bank is not behind the curve.

“It’s part of their market containment strategy” as they gradually raise rates, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey.

It’s a strategy that might not work much longer, according to Allen Sinai, who heads Decision Economics Inc. in New York and who sees unemployment dropping to 4.3 percent by the end of 2017.

In the past, investors regularly doubted that the Fed would raise rates as much as it said it would -- and they proved to be right. In the future, they may question whether the central bank is moving fast enough in tightening credit, Sinai said.

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