Federal Reserve Chair Janet Yellen this week shared with congressional leaders an optimistic outlook on the U.S. economy, which she expects to continue expanding over the next few years. She also tried allaying concerns over inflation, ensuring lawmakers that its recent ho-hum performance is the exception, not the rule.
Yellen ventured to Capitol Hill on Wednesday to deliver testimony on the Fed’s semiannual monetary policy report, a detailed overview of the state of the nation’s economy. Her comments met most analyst expectations, although the content of her message didn’t offer much specificity.
Speaking before the House Financial Services committee, Yellen touted some of the year’s economic victories so far, including measurable job gains , lower unemployment and the housing market’s ongoing recovery, before she addressed the uncertainty surrounding inflation, which has been relatively benign this year.
The Fed chief maintained that she and her colleagues intend to raise interest rates at least one more time this year, although she did not divulge when said increase will happen. She also did not give an exact timeline on when the Fed will begin unwinding its $4.5 trillion balance sheet, a process that will involve allowing its collection of Treasuries and mortgage-backed securities to gradually roll off. The Fed has said before — and Yellen said it again Wednesday — that the process will begin sometime this year.
On inflation, Yellen didn’t waver from past sentiment that she views weak inflationary measures as a temporary anomaly. Although inflation has undershot its target for about five years now, Yellen reiterated Wednesday that the soft readings are the result of “special factors” in the market, particularly an unexpected drop in prices for prescription drugs and cellphone plans.
She added that core inflation this year reached 1.8 percent, nearly hitting its target, and that she feels labor market growth will likely put upward pressure on wages and prices.
“Some temporary factors appear to be at work,” Yellen said during the hearing’s question-and-answer session. “It’s premature to reach the judgment that we’re not on the path to 2 percent inflation over the next couple of years.”
Should we put too much stock in the subtle change in Yellen’s language? Last month, she indicated that weak inflation was “significantly” affected by one-off price reductions in certain categories. She called the phenomenon “idiosyncratic” during her June 14 press conference. This week, she said those price drops are “partly” responsible for sluggish inflation.
Economists have honed in on the wording switch and speculate that Yellen may not be as confident in the cause behind flattening inflation as first believed, or she’s hedging her bets.
That could be the case, or it could just be an issue of semantics.
Other highlights of Yellen’s testimony included reports of increased consumer spending and business investment, which have helped reinforce the country’s manufacturing production and exports. She eschewed some lawmakers’ request for the Fed to release a formula it would use to determine the level of its benchmark interest rate. Yellen rebutted that the Fed uses several policy rules to guide how it makes decisions.
“Such prescriptions cannot be applied in a mechanical way,” she said. “Their use requires careful judgment.”
Yellen also sought to calm concerns that the Fed may raise rates too quickly, suggesting instead that future rates will be gradual and fewer in number since the economic factors suppressing the neutral rate will diminish over time. The neutral rate is the level at which the Fed’s benchmark interest rate neither boosts nor stalls the economy.
Her comments set off a rally in the bond market as prices moved up and yields fell. Yield on the 10-year Treasury Note, which had hit a recent peak of 2.38 late last week, dropped to 2.30 percent. The 30-year bond yielded 2.89 percent while the Dow Jones closed at a record 21,532.
In other market news…
U.S. producer prices increased slightly in June, increasing by 0.1 percent, as the rising cost of services offset falling energy prices, according to the Producer Price Index, which measures the average change over time in the prices received by domestic producers of goods and services. About 80 percent of this increase can be attributed to a 0.2 gain in services.
The Consumer Price Index was unchanged in June, meaning there was no fluctuation in the cost Americans pay for goods and services.
Retail sales disappointed yet again, falling 0.2 percent instead of going up 0.1 percent as analysts hoped. This was the second consecutive month retail sales declined, raising doubt over whether the economy is accelerating at the pace economists believed. Americans slowed down on spending at service stations, clothing stores, supermarkets, restaurants and bars. In May, retail sales dropped 0.3 percent against the 0.1 percent forecasted.
These flat to negative readings will get Yellen and the Fed’s attention as they have noted that any future rate hikes will be data dependent. Any prolonged weakness in the economy will certainly set a dovish tone from the Fed.
The European connection
For the first time in three years, European Central Bank President Mario Draghi will address the Fed at its closed-door August conference in Jackson Hole, Wyo., according to the Wall Street Journal. His speech is expected to touch on the ECB’s confidence in the eurozone economy and its gradual weaning off its stimulus bond-buying program.
The last time Draghi appeared at the Wyoming conference, in 2014, it heralded the start of the eurozone’s bond buying (or quantitative easing) program about the same time the Fed decided to end its own.
Should the eurozone wind down its QE program, it would realign the world’s two most influential central banks for the first time in nearly four years. It’s possible the ECB could take cues from the Fed and, as it begins reducing its purchases of bonds, begin nudging interest rates upward. And because the U.S. is a key player in the global economy, any chance for higher rates in Europe could translate into a chance for higher rates here.