Janet Yellen gave her semi-annual testimony before the US Congress and the tone of her comments revealed a slightly more cautious tone. Yellen’s testimony implied a March rate increase is unlikely but that the Fed is still being careful not to rule anything out beyond that while she reiterated the Fed’s expectation of gradual interest rate increases. Pricing in US cash markets currently implies a low probability of an increase at the next FOMC meeting.
Yellen said financial conditions have become less supportive of US economic growth. Jitters in the junk bond market which arose after the collapse of the Third Avenue Focused Credit Fund, had led to higher lending rates up and tightened commercial lending standards and if those trends continue, U.S. economic growth could be hurt.
Offshore developments could weigh further on the U.S economy, she said, while emphasizing that officials are watching developments in global financial markets carefully. The impact of a slowing Chinese economy and its financial market turmoil is a major concern and the US economy is also being hampered by a higher USD, which is hurting the US export sector and making life more difficult for US businesses which compete against imports.
When the topic of negative interest rates arose, Yellen said she wasn’t aware of any law that prevented the Fed from using negative rates. The Fed had considered using negative rates in 2010 but the idea was dismissed. (A 2010 Fed memo raised some doubts about the 2006 Financial Services Regulatory Relief Act allowing such a move). Yellen said it was unlikely the Fed would cut the official rate anytime soon from its current 0.25%-0.50% target range.
While her testimony placed a heavier emphasis of downside risks, the Fed chair noted how the unemployment rate was under 5.0% and the low price of oil could further stimulate already-consistent consumer spending. Even with gradual rate increases, she said the Fed anticipates “labour market indicators will continue to strengthen.”
Westpac said the overall impression is one of a Fed likely to remain on hold in March but intent on gradual increases in interest rates. ANZ’s view was the FOMC “will cut its inflation outlook and probably tweak its GDP forecasts and its ‘dot plot’ in March”. It expects the number of rises this year to be limited to two, or three at the most, rather than the four implied by the last FOMC statement.
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