The Federal Reserve is preparing to consider interest rate hikes “on a meeting-by-meeting basis,” Fed Chair Janet Yellen told a congressional committee on Tuesday, a subtle shift of emphasis that helps lay the groundwork for the Fed’s first rate hike since 2006.
In remarks to the Senate Banking Committee, Yellen described how the Fed’s rate-setting policy committee will likely proceed in coming months – first by removing the word “patient” in describing its approach to rate hikes, then entering a phase in which rate hikes are possible at any meeting.
That approach could open the door to an interest rate increase as early as June, though investors interpreted Yellen’s testimony overall as likely indicating a later date for liftoff. By the end of her two-hour appearance before the Senate Banking Committee, short-term rate futures contracts showed traders had shifted their expectations of an initial rate hike from September to October, according to data collected and analyzed by CME FedWatch.
Yellen, however, said that even as the Fed refines its language in coming weeks, investors should not construe that as a sign the central bank is wed to a rate hike at any particular meeting. Rather, she said, when the word “patient” disappears it means the Fed will merely have full flexibility to act if its judges the economic data warrant it.
The Fed has been struggling in recent months to move away from the sort of forward guidance it has relied on through the crisis to influence market behavior, without at the same time triggering a market overreaction with each tweak to its policy statement. Yellen’s comments on Tuesday marked another step in that process.
“If economic conditions continue to improve, as the committee anticipates, the committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis,” Yellen said.
“Before then, the committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the committee will necessarily increase the target range in a couple of meetings.”
Yellen’s discussion of forward guidance was part of prepared testimony that included a broad overview of a U.S. economy that appeared to be surging forward with strong job growth and a continued post-financial crisis expansion – conditions largely consistent with a rise in interest rates later this year.
Analysts said the testimony did little to nail down the likely date of a rate hike, with her testimony and answers to questions veering between confidence in a “solid” recovery and continuing concerns about weak wages and other signs the labor market is not fully healthy.
“I would suggest that Yellen is still keeping a very open mind, still in no hurry to give a signal that a rate hike is imminent,” said Brian Dolan, head market strategist at New Jersey-based Drivewealth LLC.
Lack of inflation a worry
Alabama Republican Senator Richard Shelby, the chair of the Senate Banking Committee, led a discussion that confronted Yellen with a broad set of concerns – from currency manipulation among U.S. trading partners to whether Congress should delve more deeply into the Fed’s affairs. Shelby has scheduled a separate hearing next week on Fed oversight, and challenged Yellen on the issue in his opening statement.
With a more than $4 trillion balance sheet from its various crisis-fighting efforts, “many question whether the Fed can rein in inflation and avoid destabilizing asset prices,” Shelby said. “I am interested to hear whether the current Chair … believes the Fed should be immune from any reforms.”
Yellen was adamant.
Pending legislation that would let the Government Accountability Office review monetary policy “would politicize monetary policy,” Yellen said, and “beyond a shadow of a doubt” make the Fed less effective.
On Wednesday she will testify before a House of Representatives committee.
Just completing her first year as Fed chief, Yellen said she felt U.S. labor markets and other key economic indicators “have been increasing at a solid rate.” However, she said she still feels the job market is not fully repaired, and that the U.S. outlook remains somewhat clouded by a weaker-than-hoped-for global economy, stalled wage growth, and falling inflation.
None of those factors on their own may be enough to keep the Fed from raising interest rates later this year. Rates have been near zero since the financial crisis hit in 2008, part of a record effort by the central bank to repair the damage of the Great Recession.
But the lack of inflation has made some Fed policymakers hesitant to commit to raising rates until they are more certain the United States is not headed down the same path as Europe or Japan, mature industrial economies that are struggling to maintain growth.
The Fed considers a steady 2 percent annual inflation rate a sign of overall economic health – consistent with its own ability to return interest rates to a normal level, and not so high or low that it distorts household and business spending and investment decisions. Though the current weak prices are considered likely to be a temporary result of the collapse in oil prices, doubts remain.
Yellen’s statement could set the stage for the Fed to remove the “patient” reference as soon as its next meeting in March, a step policymakers began discussing in January according to recently released Fed minutes. Several policymakers, including some centrists on the committee, have said they feel an interest rate increase should be on the table by June, after the intervening Fed policy meeting in April.
The discussion of forward guidance in Yellen’s testimony is an effort to extricate the Fed from a perhaps unforeseen constraint it created when the word “patient” was put in its statement in December. Yellen defined patient as a “couple” of meetings, and policymakers soon became concerned, according to the most recent Fed minutes, that investors would view any removal of “patient” as a sign that interest rates would definitely rise two meetings later.
