March goes live: breaking down Janet Yellen’s testimony

Federal Reserve (Fed) Chair Janet Yellen endured a grueling and highly politicized two-day round of Congressional testimony. Senators and congressional representatives asked numerous politically charged questions about Dodd-Frank and the Fed’s role in financial regulation. The politicians lobbed questions about everything from the economic impacts of climate change and the collapse in farm prices, to the lack of jail time for any actors in the financial crisis. As usual, Chair Yellen responded to all questions with the highest degree of integrity and professionalism.

For all the hours of political grandstanding from representatives, the market focused on a few key statements for her prepared testimony. A key line stated, “Waiting too long to remove accommodation would be unwise, potentially requiring the [Federal Open Market Committee] to eventually raise rates rapidly.” This statement, combined with the rest of her prepared remarks, meant that the market put March on the table as a live meeting. The market-implied probability of a fed funds rate increase in March moved from 30% at the start of Tuesday to 42% at midday on Wednesday. Stronger-than-expected CPI inflation and retail sales numbers released Wednesday further bolstered those expectations.

Despite the market reaction, this somewhat hawkish tilt from Yellen’s testimony is not surprising. Her remarks reinforce the policy statement from the February Federal Open Market Committee (FOMC) meeting. In addition, the key statement above was quite similar to her January speech at the Commonwealth Club in San Francisco. At that time, she stated, “Waiting too long to begin moving toward the neutral rate could risk a nasty surprise down the road.” The U.S. economy is in far better shape at the start of this year compared to last year. Inflation expectations have rebounded as commodity prices have stabilized, business surveys and manufacturing have recovered from recession like territory at the end of 2015, and wage growth continues to trend modestly upward. If data continue to progress, the Fed will move more quickly this year, compared to last year. The reality is that if the Fed plans to move three times this year, a rate hike in the first half of the year is likely.

The Fed’s balance sheet also came up during questions. Chair Yellen emphasized that the Federal Reserve would not use the balance sheet as an active policy tool. This statement does provide some clarification in the Fed’s thinking. For example, in contrast, Boston Fed President Rosengren recently stated that the Fed could potentially use the balance sheet to tweak the yield curve – in other words, using it as an active policy tool. The FOMC members or regional Fed governors will likely continue to make clarifying statements about the process of reducing the balance sheet throughout the year. In fact, that discussion could be accelerated if Yellen and Fischer want a clear plan in place ahead of their term expirations in 2018.

The market tasked Yellen with communicating the Fed’s view on the economy and the pace of policy tightening; she did just that in her testimony. The U.S. economy is doing okay. Yes, it has some problems, but this year it is ready for a bit faster pace of rate increases from the Fed.


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