Federal Reserve

Fed’s Yellen sees more US rate hikes ahead

Fed chief defends talks on global financial regulations

PUBLISHED : Wednesday, 15 February, 2017, 1:23am
UPDATED : Wednesday, 15 February, 2017, 1:23am

Federal Reserve Chair Janet Yellen said more interest-rate increases will be appropriate if the US economy meets the central bank’s outlook of gradually rising inflation and tightening labour markets.

“At our upcoming meetings, the committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal funds rate would likely be appropriate,” she told the Senate Banking Committee in prepared remarks on Tuesday.

Yellen’s semi-annual report on monetary policy is her first since Donald Trump became president vowing to boost US growth, which could push the Federal Open Market Committee to pick up the pace of rate hikes if such steps fan higher inflation. She reiterated that falling behind on inflation could harm the economy and possibly cut short the expansion.

“Waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession,” she added.

The Fed, which has only raised rates twice since the recovery began in 2009, has pencilled in three quarter-point rate increases in 2017, as the economy closes in on the central bank’s goals for maximum employment and 2 per cent inflation.

Yellen gave no indication of the timing of the next hike in her prepared remarks. Investors see about a 34 per cent chance of an increase at the next meeting of the FOMC on March 14-15, up from about 30 per cent before she spoke. Treasuries fell, US stocks pared losses and the dollar rose.

Yellen said the Fed panel’s outlook for a “moderate pace” of growth is based on continued stimulative monetary policy, and a pick-up in global activity. She did not mention Trump administration proposals as a key element in the central bank’s forecast.

In response to questioning, Yellen said Fed policy makers will be discussing in coming months their strategy for the balance sheet, which swelled to about US$4.5 trillion after the crisis from less than US$900 billion in 2006 as the central bank sought to hold down long-term market rates.

She said she expects the balance sheet to end up being “substantially smaller” than it is now, with policy makers wanting to shrink in an “orderly and predictable way.” The Fed doesn’t want to use the balance sheet as an active policy tool and it should eventually be comprised primarily of US Treasuries, she said.

On the economy, she said in her opening statement that consumer spending has continued to rise at a “healthy pace,” supported by gains in household income and wealth, favourable sentiment and low rates. The recent rise in mortgage rates “may impart some restraint” on housing markets, she said.

Fed keeps US rates unchanged, is upbeat on economy

The Fed chief said changes in fiscal and economic policies could affect the outlook, though she declined to speculate how, adding that it’s “too early to know” what policy changes will be put in place. She urged lawmakers to focus on investments that would improve living standards and raise productivity while noting that she hoped any changes would keep fiscal accounts “on a sustainable trajectory.”

Trump’s victory could expose the US central bank to reforms favoured by his Republican party, which still controls both chambers of Congress. Yellen could previously rely on President Barack Obama, a Democrat, to shield with his veto any perceived encroachment on Fed independence.

The shift in power may force her to engage more with lawmakers than in the past. Republicans want to roll back post-crisis banking regulations enshrined in the Dodd-Frank Act, arguing it hurts growth by making credit scarce for small businesses.

Expect a more hawkish Fed in the second half of 2017

While Yellen did not mention financial regulation in her remarks, lawmakers had many questions on the issue as the hearing progressed.

In his opening remarks at the hearing, Senate Banking Committee Chairman Mike Crapo said “it is time to reassess what is working and what is not” with financial regulations, which need to “strike the proper balance” between the safety of the system and economic growth.

Trump’s opportunity to influence regulatory policy improved last week when Fed Governor Daniel Tarullo, who oversees bank regulation, announced his departure in early April. It also means that Trump can fill three of the seven Fed Board seats, where there are two existing vacancies, while Yellen’s own term as chair ends in February 2018.

Yellen defended the central bank’s work with foreign counterparts to align financial-industry oversight, deflecting a Republican lawmaker’s demand that such efforts be halted for President Trump’s regulatory review.

Participating in development of international banking rules enables the Fed to help shape the standards in ways that promote US financial stability and the competitiveness of US companies, Yellen wrote in a letter to North Carolina Representative Patrick McHenry.

“In exercising our longstanding authorities and responsibilities for consulting with our foreign counterparts, we share the objective that the whole US government must work constructively to ensure a strong, stable US economy and financial system,” Yellen said in the February.10 letter.

McHenry, who is vice chairman of the House Financial Services Committee, said in a January 31 letter to Yellen that it was “unacceptable” that the Fed was conducting international talks after Trump took office but before he had a chance to put his own people in place.