Yellen Hints at Gradual Hikes and Further Asset Purchases

Fed chairperson hints that rate hike could be possible as early as September 2016

j1In a follow-up to our story (published on August 25th) on Federal Reserve Chairperson Janet Yellen’s speech which was scheduled on Friday, August 26th, 2016, in Jackson Hole, Wyoming, it appears that Yellen still has optimism in her forecast-based policy using traditional economic models. In her speech to central bankers and economists, Yellen said that while the U.S. economy has strengthened to the point that interest rate hikes are possible, further asset purchases must also be part of the Fed’s strategy to stabilize the U.S. economy. That being said, Yellen has expressed confidence that tighter labor markets will push inflation to the Fed’s 2% goal over a period of time. Yellen was expected to provide guidance on the interest rate policy in the near term, which will have the biggest impact on short-term market moves, especially if she follows in Stanley Fischer’s relatively hawkish tone.

Yellen’s speech on Friday points to a possible rate hike as early as September 2016, if the August 2016 jobs data maintain the same pace as seen in July 2016. The Federal Open Market Committee (FOMC) is scheduled to meet on September 20-21st, 2016 to discuss these issues. The probability of a hike at the upcoming Fed meeting has risen to 38% from 15% two weeks ago, according to Bloomberg. Yellen’s viewpoint is seen to differ with a minority group of Fed officials who are more pessimistic about the relationship between labor markets and prices.

Yellen said that the continued solid performance of the labor market has strengthened the probability of a U.S. rate hike in the coming months. Yellen’s remarks also signaled that she did not need to see actual inflation rising toward 2% in order to hike interest rates. While inflation would reach their 2% target over the next couple of years, gradual and timely moves were required to sustain employment and inflation nearer to the Fed’s statutory objectives.

Source: Bloomberg
Source: Bloomberg

In recent meetings, Fed officials have had a divided opinion about the economic scenario and its relation to the hiking of interest rates. Most officials have anticipated that the negative impacts of lower energy prices and non-oil imports would subside over time and the tightening labor markets would pave the way for wage growth. Others have been skeptical about the traditional relationship between tighter resources and prices.

The FOMC raised its target for the federal funds rate to a range of 0.25% to 0.5% in December 2015, after keeping the benchmark rate near zero levels for the past seven years. The Fed has deterred hiking interest rates at all five meetings this year, and futures markets have priced in about a 30% chance of another increase in September 2016. Over the past year, U.S. payroll gains have averaged about 200,000 jobs a month, while inflation has remained steady at nearly 1.7%. The U.S. Department of Labor will report data on August employment on September 2nd, 2016, providing the Fed a chance to review its interest rate policy in the near term. The graph below shows the decline in the jobless rate.

Source: Bureau of Labor Statistics, Bloomberg
Source: Bureau of Labor Statistics, Bloomberg

While U.S. economic growth has not risen as per expectations, it has been sufficient to kick start an improvement in the labor market. Over the next few months, Yellen expects moderate GDP growth coupled with strengthening of the labor market, with inflation rising to 2% over the next few years. Based on this economic outlook, the FOMC believes that a gradual increase in the federal funds rate would bode well to achieve and sustain employment and inflation near its statutory objectives.

Yellen’s speech comes at a time when global central banks are re-evaluating their future strategies for monetary policies, in a scenario where aging populations, declining productivity, and below-target inflation rates are likely to result in lower peaks in their policy interest rates. The reassessment gains significance because central banks are likely to reach the zero-boundary on their policy rates faster in the next recession.

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