Tightening financial conditions driven by falling stock prices, uncertainty over China and a global reassessment of credit risk could throw the U.S. economy off track from an otherwise solid course, Federal Reserve Chair Janet Yellen said on Wednesday in prepared testimony to Congress.
In testimony that combined a steady-as-she-goes account of Fed policy with an acknowledgement of intensifying risks, Yellen said there are good reasons to believe the United States will stay on a path of moderate growth that will allow the Fed to pursue "gradual" adjustments to monetary policy.
Family incomes and wealth are rising, domestic spending "has continued to advance," and business investment outside the oil sector accelerated in the second half of the year, she said. Yellen said she expects the labor market to continue to improve and inflation eventually rise toward the Fed's target despite a recent drop in inflation expectations cited by some policymakers as particularly unnerving.
But Yellen acknowledged that some of the weaknesses in the global economy have become self re-enforcing, with weak growth in major manufacturers like China and oversupply on commodity markets rattling the world's oil and mineral exporters. A broad sense of a world slowdown, in turn, and uncertainty about the depth of China's problems, has tightened financial conditions for U.S. businesses.
"These developments if they prove persistent, could weigh on the outlook for economic activity and the labor market," Yellen said in remarks prepared for her semi-annual appearance before the House Committee on Financial Services. A hearing before the committee begins at 10 a.m.
An accompanying report said the U.S. financial sector "has been resilient" to stress from oil and weakening corporate debt markets around the world, with "limited" exposure among large U.S. banks. But "if conditions in these sectors worsen...wider stresses could emerge."
Yellen singled out uncertainty over recent changes in China's currency policy and the prospects for its economy as a particular culprit behind recent financial market volatility, with the potential to drag down other countries dependent on commodity and other exports to China.
"Should any of these downside risks materialize, foreign activity and demand for U.S. exports could weaken and financial markets could tighten further," she said.
Nevertheless, Yellen held firm to an overall sense that U.S. growth would continue, and that the world would eventually fall in step.
"Ongoing employment gains and faster wage growth should support the growth of real incomes and therefore consumer spending," Yellen said. And with other central banks maintaining loose monetary policy, "global economic growth should pick up over time."
The Fed "expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in coming years and that labor market indicators will continue to strengthen," Yellen said.
The Fed in December raised interest rates for the first time since the 2007 to 2009 financial crisis and recession, ending a seven-year run near zero. Policymakers at the time anticipated four more hikes this year, though investors have discounted that amid the risks cited by Yellen and continued low inflation in the United States.
(Reporting by Howard Schneider and Lindsay Dunsmuir; Editing by Andrea Ricci)