Careful, dollar bulls! Unlike some of her FOMC buddies, Fed head Janet Yellen ain’t so eager to hike interest rates just yet so the U.S. currency was forced to return its recent forex gains. In case you weren’t able to catch her full speech, here are the main points you need to remember from her testimony this week:
1. Proceed with caution
Perhaps the biggest factor that put the Greenback in selloff mode against its forex counterparts yesterday was Yellen’s reminder that the Fed should move cautiously when it comes to monetary policy tightening. For several market watchers, this doused hopes of an April FOMC hike, contrary to what Fed policymakers Lockhart and Dudley suggested in their testimonies last week.
Head honcho Yellen explained that the U.S. central bank has more than enough tightening options on the table (i.e. rate hikes ’til kingdom come!) should economic growth continue to pick up but that it has few tools left in case the downturn worsens. In the latter scenario, the Fed could simply pledge to keep borrowing costs low for much longer, bring interest rates back to near zero, or even resume long-term bond purchases.
2. Weaker global economic and financial conditions
One of the reasons why Yellen is still discussing the idea of further stimulus is that she believes that weaker global economic and financial conditions pose risks to the U.S. outlook. In particular, she highlighted the consensus view that “China’s economy will slow in the coming years as it transitions away from investment toward consumption and from exports toward domestic sources of growth” and that this shift will be accompanied by a lot of uncertainty.
Aside from that, Yellen also explained that the continuous drop in oil prices might once again lead to financial strains among energy-rich nations, increased layoffs, and even cutbacks in government spending. Further declines in crude oil could have adverse spillover effects on the global economy and likely weigh on investor sentiment, possibly causing tighter financial conditions.
3. Lower inflation expectations
Another reason why Yellen gave cautious vibes is the increased downside risks to their inflation outlook. Again, the slump in oil prices is mostly to blame, as Yellen admitted that it may take longer for the U.S. economy to achieve its 2% inflation outlook than initially expected and that this “might require a more accommodative stance of monetary policy than would otherwise be appropriate.”
4. Hiring and spending remain strong
On a less downbeat note, Yellen acknowledged the strength in the labor market and domestic spending activity. After all, the U.S. economy has managed to add a monthly average of 230,000 jobs for the past three months and that income gains have supported consumer spending.
In addition, lower gasoline prices have also allowed households to enjoy a larger chunk of disposable income, allowing the consumer sector to offset declines from manufacturing and net exports. Still, she cautioned that global developments and dollar appreciation could continue to weigh on demand for U.S. goods, possibly putting a drag on production and hiring down the line.
Even though her remarks seem to have lowered the odds of seeing a Fed rate hike during the next few months, Yellen pointed out that their expectations are not set in stone and that their plan will continue to evolve depending on market developments. She emphasized that their decisions will be data-dependent and that the Fed will maintain effective communication in order to prevent adverse financial shocks.