Janet Yellen has given the Federal Reserve's strongest signal yet that it is on the cusp of lifting rates again, predicting that the pace of tightening is likely to accelerate from the sluggish speed set in 2015 and 2016 as it seeks to prevent the US from overheating.
Following a week of hawkish messages from top US rate-setters, the Fed chairwoman told an audience in Chicago on Friday that a further increase in short-term interest rates was likely to be "appropriate" at the Fed's policy meeting on March 14th and 15th if employment and inflation stay in line with officials' expectations.
While reiterating her longstanding guidance changes will happen only gradually, Ms Yellen added that, barring unexpected developments, the monetary stimulus the Fed has provided the US economy would be reduced at a quicker pace than in 2015 and 2016.
The mounting signals the Fed’s third rate increase since the 2007 financial crisis is imminent has helped spark a global rally in stocks, with investors viewing a hike as a sign policymakers believe US economic growth is becoming stronger and more sustainable.
Bullish
Despite dipping towards the end of the week, the S&P 500 index notched up its sixth straight week of gains – with all four of the biggest stock gauges hitting new records Wednesday – and the 10-year US treasury yield climbed 19 basis points, the most since mid-November, to end the week above 2.5 per cent again.
The dollar index gained 0.8 per cent over the past five trading days, propelled by bets on a more bullish Fed.
Ms Yellen has traditionally been viewed as an instinctive dove who waits until the last minute before lifting rates. The Fed’s once-a-year pace of tightening in 2015 and 2016 solidified that impression.
But a confluence of factors has prompted US policymakers to take a more aggressive approach. This includes an economy that is at or near full employment, firming price growth that has taken the Fed’s favoured measure of headline inflation closer to its 2 per cent target, and solid consumer spending.
In addition, many investors are anticipating a looser fiscal policy to emerge from negotiations between the Trump administration and Congress.
“We currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect,” Ms Yellen said in her Chicago remarks.
“Indeed, at our meeting later this month, [policymakers] will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.”
Ms Yellen spoke after a procession of her Fed colleagues hammered home in recent days the message that a third rate rise is likely imminent following quarter-point increases in 2015 and 2016. The bullish chorus led to a violent shift in investor expectations, with the markets-implied odds on a March interest rate increase – as indicated by Fed funds futures – jumping from about a third last week to 90 per cent earlier on Friday.
Remarkable resilience
In her speech, Ms Yellen said the US economy had demonstrated “remarkable resilience” in the face of shocks from overseas in recent years, and that developments since mid-2016 have reinforced Federal Open Market Committee members’ confidence that the economy is on track to meet the Fed’s employment and inflation goals. Continuing to raise rates will probably be necessary to keep the US economy from “significantly overheating” in the years ahead, Ms Yellen added.
“Given how close we are to meeting our statutory goals, and in the absence of new developments that might materially worsen the economic outlook, the process of scaling back accommodation likely will not be as slow as it was in 2015 and 2016,” she said.
The Fed’s December forecasts suggested there would be three quarter-point rate increases over the course of 2017. Ms Yellen said such an increase would be consistent with the Fed’s strategy of gradual rate rises and the goal of pushing the real federal funds rate close to some estimates of its neutral level. The Fed has projected further increases in 2018 and 2019.
Many investors had until recently been expecting the Fed to sit tight until May or June before the US central bank lifted its target range for the federal funds rate to 0.75 per cent to 1 per cent. But signals from officials including Jerome Powell and Lael Brainard of the Fed’s board of governors, Robert Kaplan of the Dallas Fed, and John Williams of the San Francisco Fed, have radically changed expectations.
– Copyright The Financial Times Limited 2017
