Mike & Co. —
The Chair of the Federal Reserve went before House Financial Services to provide a report on the nation’s economic condition, a kind of bi-annual checkup. No news was made, no fireworks went off and no market mood swings occurred. As for the Fed’s next move, it’s wait-and-see a little while longer.
We thought it might happen in March, signs pointed to it. Now, the guess is June (sound familiar?) For details, don’t wait, see below.
Fed Chair Yellen testified before House Financial Services this morning for the Federal Reserve’s bi-annual Monetary Policy Report. These appearances allow Yellen to explain the Fed’s, actually the Federal Open Market Committee (FOMC)’s, analysis and projections regarding America’s economic performance as well as to signal the factors underlying its actions in the months ahead.
The rate change in December 2015 was the first time the Fed raised rates since 2006 — some worry that even a modest increase in rates at this juncture would further slow already limited economic growth after years of uncertainty.
The bottom line: the FOMC won’t rollback rates in March and it’s not likely to raise them either. The Fed likes what it sees in the labor market, wage growth looks strong, and emerging market missteps continue to be a threat to the US economy but perhaps not an immediate one. The next rate move is almost certain to be an increase but it could wait until June or later.
Yellen reiterated much of the FOMC statement from last month: the labor market remains strong, but shows some signs of remaining slack, that the low inflation we have seen is caused by “transitory” effects (low energy prices), and that global market uncertainty creates some level of risk for slow growth at home and abroad. Though Yellen did not make a prediction on how long these transitory market effects would last, a number of forecasts for oil prices show the dip lasting through 2016.
Expanding on global growth issues, Yellen said “These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices could provide some offset,” she added: “Foreign economic developments, in particular, pose risks to US economic growth.”
The GOP is generally critical of “accommodative” (lower) Fed rates. High-net-worth individuals benefit the most from high rates through dividends and interest from savings. Low rates allow more growth for the middle- and lower-classes at the risk of inflation, tacitly supporting Democrats’ progressive fiscal policy goals. Some conservative economists have gone so far as to blame low interest rates pushed by the Fed in the 1990’s for the market meltdown in 2007, claiming that cheap credit was the cause of the overheated housing market.
Strong Labor Market
Discussing the labor market in greater detail, Yellen pointed to the cumulative increase in employment since 2010 of 13 million jobs. The rate in January fell to 4.9 percent, 0.8 points below its level one year ago; measures of labor market conditions such as the number of people who are working part-time but want to move to full-time positions and the number of individuals who want to work but haven’t searched recently are also decreasing steadily. Regarding these broader labor market indicators Yellen testified that “… these measures remain above the levels seen prior to the recession, suggesting that some slack in labor markets remains. Thus, while labor market conditions have improved substantially, there is still room for further sustainable improvement.”
As always, Yellen was careful not to give hints on what the Fed is planning to do in future meetings; speaking on the path forward for the Fed Funds rate Yellen said “Of course, monetary policy is by no means on a preset course. The actual path of the federal funds rate will depend on what incoming data tell us about the economic outlook, and we will regularly reassess what level of the federal funds rate is consistent with achieving and maintaining maximum employment and 2 percent inflation.”
Yellen was asked about the chances of the FOMC rolling back the rate hike it announced in December: “I do not expect the FOMC is going to be soon in the situation where it’s necessary to cut rates If the FOMC delayed the start of policy normalization for too long, it might have to tighten policy relatively abruptly in the future to keep the economy from overheating and inflation from significantly overshooting its objective. Such an abrupt tightening could increase the risk of pushing the economy into recession.”
Comment on Dodd-Frank
During the Q&A portion of her testimony, Yellen was asked about financial regulation, both in terms of breaking up the banks and enforcing the regulations brought on by Dodd-Frank.
In response to being asked if the Fed is trying to break up the banks, she responded: “We are using our powers to make sure that a systemically important institution could fail, and it would not have systemic consequences for the country.” Her answer was interesting, because she’s not outright saying the banks will be broken up or reduced, just that the Fed is trying to ensure that even if they did fail, it wouldn’t negatively effect the economy.
Yellen was also asked about the burden of new Dodd-Frank regulations on banks. She responded: “For our part, we’re focused on doing everything that we conceivably can to minimize and reduce the burden on these banking organizations. We’ve been conducting an EGRPRA review to identify potential burdens that our regulations impose.” An EGRPRA review is connected to the Economic Growth and Regulatory Paperwork Reduction Act, which requires regulations imposed on financial institutions to be reviewed by the agencies at least once every 10 years. The purpose is to prevent burdensome regulations that could hinder a bank’s ability to serve its customers.
The Bottom Line
Fed watchers make their living by trying to predict what the FOMC will or won’t do at their meetings, and on days when Yellen is scheduled to testify before Congress you can bet that they’re listening intently. While Yellen was careful not to project the Fed’s moves, the general sentiment in the markets is that FOMC won’t be raising rates at its March meeting. The CME Group FedWatch tool, which estimates FOMC rate hikes based on its futures prices, predicts a 95% probability that the Fed will maintain its current rate target in March. Some forecasters go even further — expecting that the funds rate won’t be raised all year.
Traders see the ongoing economic struggles of emerging economies, particularly in China, as evidence that the Fed won’t continue with its scheduled 4 rate hikes this year. Certainly, considering the testimony today that 1) continued emerging market uncertainty can weigh down the US economy and 2) that poor performance in the US economy would cause the Fed to change course on its rate hike schedule, a link between poor emerging market performance and fewer Fed rate hikes seems plausible. Certainly the trading on Fed fund futures indicates that the markets believe this is the case.