‘Relatively Soon’: Fed’s Yellen Vows Rate Hikes Amid Brighter Growth Outlook

Kristian Rouz – US Federal Reserve Chair Janet Yellen in her testimony before Congress’ Joint Economic Committee said the pace of base interest rate hikes would remain gradual, and the next hike is coming up “relatively soon.”

Yellen’s commentary comes amidst renewed declines in bond values across the globe, with higher yields pushing natural borrowing costs higher and thus prompting a proportional Fed action. President-elect Donald Trump’s team of economic advisors, meanwhile, has encouraged the markets with their fiscal stimulus promise, resulting in faster growth expectations stirring the anticipation of a quicker pace in interest rate hikes.

Yellen noted that the Federal Reserve would continue adjusting its economic growth outlook in accordance with the Trump team’s economic planning, as hundreds of billions in tax cuts and increased governmental spending would likely unwind the inflationary spiral. Should inflation exceed the Fed’s 2pc target, the regulator will inevitably hike rates. The question remains, whether the Fed would be willing to undertake a pre-emptive action raising rates in December – a month before Donald Trump actually takes the office.

“The evidence we have seen since we met in November is consistent with our expectation of strengthening growth and improving labour markets and inflation moving up,” Yellen said. “The risk of falling behind the curve in the near future appears limited.”

The yield curve, meanwhile, has steepened substantially for the first time since corporate earnings started their lengthy plunge in mid-2015 (brief episodes of steepening yield curve had occurred during this year’s electoral campaign when Trump led in opinion polling). A likely indication that the US might avert a recession by simply having elected Trump into office, the steepening yield curve – the discrepancy between the profitability of short-term and long-term bond investment – reflects the strengthening market confidence in the US productive forces and Main Street economy.

“Yellen’s testimony ignored the very real possibility of substantial fiscal stimulus next year,” Ian Shepherdson of Pantheon Macroeconomics Ltd. said. “[Yellen] does not want the Fed to become even more of a political punch bag than it is already.”

Indeed, Yellen was extremely cautious in her testimony, avoiding any rhetoric that could reflect the market anticipating a fiscal stimulus, thus far based off the statements from the Trump camp. No substantial move in Washington has been made yet, and it would take another two months before the stimulus would commence. The recent market dynamics are largely speculative, and Yellen has an understanding of it.

“When there is greater clarity about the economic policies that might be put into effect the (Federal Open Market Committee, FOMC) will have to factor those assessments of their impact on employment and inflation and perhaps adjust our outlook,” Yellen said.

The dollar, however, rose to a thirteen-and-a-half-year high due to the selloff in the bond markets – with the definitive news arriving from overseas. In Italy, bonds showed a record drop, with yields skyrocketing, diverting capital into stocks and putting additional pressure on the European Central Bank to warp up its stimulus.

One thing is clear for certain – the simple fact of Trump’s election into office has become a major factor moving the markets, even before he and his team are able to take action.

“U.S. economic growth appears to have picked up,” Yellen said.

The FOMC meets in Washington on 13-14 December, and most market participants and observers are putting 100pc bets on a hike by a quarter percentage point happening during the meeting. Trump’s inauguration is set for 20 January. His 100-day plan of urgent economic measures would commence shortly thereafter.

“Were the FOMC to delay increases in the federal funds rate for too long, it could end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of the committee’s longer-run policy goals,” Yellen said. “Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and ultimately undermine financial stability.”

All that means a pre-emptive action on the Fed’s part is very likely, and the Trump administration would start their economic reform in an only ‘moderately accommodative’, in Yellen’s words, monetary environment. That said, the initial efficiency of Trump’s fiscal stimulus is poised to affect growth and inflation significantly, resulting in a series of rate hikes on the Fed’s part in 2017.

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