5 Highlights from Yellen’s Interview

U.S. Fed Chairperson Janet Yellen was awarded the Radcliffe Medal at Harvard University on Friday and was then interviewed for a bit. What did she say exactly? And how did the Greenback react? Here are 5 highlights from Fed Chair Yellen’s interview that you need to keep in mind.

1. Fed is better at identifying risk

The interview started off slow, with former Fed Head Ben Shalom Bernanke introducing Yellen, and Yellen remarking that “America owes him [Bernanke] an enormous debt of gratitude.” Yellen then talked about her academic background before finally moving on to the more delicious stuff.

She first said that the Fed’s handling of the economy during the so-called Great Recession was “nothing short of magnificent,” but acknowledged that she and her fellow Fed officials, as well as most other economists, saw the warnings signs at the time, but failed to understand how the housing bubble was contributing to systemic risk (risk that affects the entire financial system), and therefore failed to see the financial crisis coming.

However, Yellen said the Fed has now gotten better at identifying risk factors that may signal another financial crisis, with systemic risk and financial stability in focus, which helps to explain why the minutes of the April FOMC meeting revealed that FOMC members were talking about using monetary policy to address financial stability risk, as well as expressing their desire to “incorporate financial stability considerations in the design of monetary policy.”

2. Yellen on the U.S. economy

Yellen also briefly expressed her views about the present state of the U.S. economy, but she carefully refrained from communicating a definitive outlook.

With regard to the overall economy, she said that “the economy is continuing to improve” and that we’ll likely see a rebound in Q2 after a relatively slow Q1. Employment metrics have also been positive overall, with the labor force participation rate slowly ticking higher since last year and the unemployment rate close to the Fed’s goal. However, wage growth hasn’t been very impressive (note: look out for this in next week’s NFP report) and the number of part-time workers clamoring for full-time jobs are still high.

Also, productivity growth has been “miserable” and “that’s a serious and negative development.” That last negative bit is not that much of a surprise, though, since Fed Governor Jerome H. Powell already spilled some of the beans in a speech that he delivered back on Thursday.

As for her views on inflation, she stated the obvious by saying that inflation is still below the Fed’s target, but is confident that deflationary pressure from lower oil prices and the Greenback’s previous bouts of strength “seem like they are roughly stabilizing at this point and my own expectation is that … inflation will move back up over the next couple of years to our 2 percent objective.”

3. A rate hike is “appropriate”

Yellen was jokingly asked if she had any market-moving statement to share, to which she replied the following:

“Growth looks to be picking up from the various data that we monitor. And, if that continues, and if the labor market continues to improve – and I expect those things will occur – we’ll continue to monitor and also we’ll assess risks to the outlook.”

“But it’s appropriate – and I’ve said this in the past – I think for the Fed to gradually and cautiously increase our overnight interest rate over time and probably in the coming months such a move would be appropriate.”

So there you have it! A rate hike is “appropriate in the coming months” if certain conditions are met. And as the April minutes of the FOMC meeting revealed and as Yellen hinted, these conditions are the following:

  • a pickup in Q2 growth
  • improving labor market conditions (wage growth in focus)
  • stronger inflation readings

Do note, however, that Yellen used the plural “months” instead of the singular “month” and that has caused some market watchers to conclude that a June rate hike is not in the cards.

Still, the Fed Head Honcho’s words were apparently enough to raise the probability of a June rate hike from 30% to 34% while a July rate hike now had a 60% probability, according to Reuters (citing the CME Group).

And if y’all can still recall, the minutes of the April FOMC meeting showed that a “couple of participants” were worried that delaying another rate hike may “potentially erode the Committee’s credibility” while “some members” were worried that the market was betting that the probability of a June rate hike “might be unduly low,” which reflects upon the Fed’s credibility, so Fed officials may still vote for a June rate hike in order to preserve or improve investor confidence.

4. Fed has limited tools

We ain’t done yet, boys and girls! Yellen was also asked what other tricks the Fed had its sleeve if another recession comes along and if that worries Yellen, to which Yellen replied the following:

“It is a concern. We have very limited scope at this point to use our traditional technique, namely lowering overnight interest rates, to support the economy if there is an adverse shock, even if we go for some time without an adverse shock and even if you take a reasonably optimistic scenario.”

“Now we did invent other tools to address stimulating the economy. We use these longer term asset purchases. And we try to shape market expectations about the path of short-term interest rates through our communications and so-called forward guidance. I think we would resort to those tools again.”

In short, the Fed has no room to cut rates further, which is an issue that was also raised during the March FOMC meeting. The only real tool left is expanding the Fed’s QE program, although trying to “shape” market expectations is also considered a tool apparently.

Yellen also said that negative interest rates were considered, but Fed officials “were concerned at the time that there could be a number of negative repercussions from lowering negative interest rates,” so including negative rates in the Fed’s toolbox was ultimately dropped for now.

5. Tightening cycle should be gradual

To top it all off, Yellen then said that:

“One of the reasons I believe we should be cautious in raising interest rates is precisely because, if we were to raise interest rates too steeply and we were to trigger a downturn, or contribute to a downturn, we have limited scope for responding and it is an important reason for caution.”

Hmm. Yellen is worried that hiking rates too fast may actually trigger or contribute to a downturn. That’s not exactly a stamp of confidence on the strength of the U.S. economy, isn’t it? And remember, the Fed already downgraded its rate hike projections during the March FOMC statement from four rate hikes within the year to just two, so it looks like Yellen wasn’t really all that hawkish, but, well, the market is what it is, and so the Greenback soared as rate hike expectations apparently got reinforced.

USD/JPY: 1-Hour Forex Chart

USD/JPY: 1-Hour Forex Chart

So, given Yellen’s statements, are you expecting a June rate hike? Answer the poll below or share your thoughts in the comment section!

 

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