Yellen keeps US Federal Reserve’s options open on interest rates rise

Janet Yellen kept the US Federal Reserve's options open on its interest rates tightening policy, urging investors not to assume that the central bank will follow a predictable pattern if it drops its pledge to be "patient" before raising rates.

The Fed chairwoman told a US Senate committee that if the central bank modified its message in its forward guidance, rate moves could follow at any meeting, as she prepared financial markets for the end of near-zero interest rates in America.

However, Ms Yellen also struck a cautious note about the economy’s performance, emphasising that while the labour market had improved, “too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.”

The central bank had promised after meetings in December and January to be “patient” before raising interest rates - and said that meant it would not make a move for at least two subsequent meetings of its monetary policy committee.

Officials suspect that if the central bank drops its “patience” pledge, investors will automatically price in rate hikes starting two meetings later, in a development that would carry echoes from the Fed-induced market “tantrum” of 2013.

Patience language

Ms Yellen said on Monday that ditching the patience language “should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings.”

Instead, she explained: “The modification should be understood as reflecting the Committee’s judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting.”

The Fed is trying to create greater scope to respond to changing economic circumstances.

While some market participants expect a rate move as soon as June, Fed officials remain conflicted over how soon to pull the trigger on rate rises given that rapid jobs growth is coupled with weak overseas conditions, low inflation readings, and a strong dollar.

Ms Yellen gave a balanced assessment of the economy’s recent performance. She stressed that while the situation in America’s labour market had been improving “along many dimensions” there was room for further improvement, with wage growth remaining “sluggish” and labour force participation stuck below estimates of its trend.

Overseas developments such as weaker outlooks in China and the euro area could pose risks to the US outlook, but on the other hand foreign central banks such as the European Central Bank had provided extra monetary stimulus.

Inflation has stuck well below the Federal Open Market Committee’s 2 per cent objective, in large part because of the tumble in oil prices. Core inflation, which strips out volatile factors like energy, has also slowed, Ms Yellen said, reflecting lower import prices and “some pass-through of lower energy costs into core consumer prices.”

Oil prices

On the other hand, the drop in oil prices will be a “significant overall plus” for the economy. And while inflation compensation has fallen in financial markets, the Fed has determined that this “mainly reflects factors other than a reduction in longer-term inflation expectations,” she said.

“Provided that labour market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 per cent objective,” she said.

Ms Yellen reiterated that, even after employment and inflation are near levels consistent with the Fed’s mandate, it may be necessary to keep the key policy rate below normal longer run levels.

“It is possible, for example, that it may be necessary for the federal funds rate to run temporarily below its normal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity,” she said. “As such factors continue to dissipate, we would expect the federal funds rate to move towards its longer-run normal level.” – (Copyright The Financial Times Limited 2015)