– Yellens’ testimony on the Monetary Policy Report to Congress contained positive assessments of the economic scenario, but also great caution. Every acknowledgement of the improvement in economic activity,….
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labour market conditions, and the price trend, was followed by considerations with which Yellen showed the intention to await further confirmation of the positive evolution of data. On the whole, Yellen made a positive assessment of the recovery, and was generally dovish on rates, once again signalling that the timing and path of rate hikes will be strongly data-dependent.
– In the statement, the succession of positive assessments corrected by calls to caution referred to both the economy as a whole and, more specifically, the labour market. Yellen said that while the economy continues to improve, “the recovery is not yet complete”: therefore, “a high degree of monetary policy accommodation remains appropriate”. Yellen noted that “significant slack remains in labor markets”, with an excessive number of unemployed workers and an inflation rate that is still below target: still very modest wage growth is indicative of the size of the slack in the economy. However, “broader measures of labor utilization have also registered notable improvements”. Inflation has risen back, while staying below 2%. The recent rise is tied in part to temporary factors. Most FOMC participants project that inflation will be between 1.5 and 1.75%: this forecast leaves room for monetary accommodation to be kept in place, and at the same time indicates a gradual reduction (still not complete) of slack.
– As regards monetary policy, Yellen did not specifically touch on the timing of the rate hike, but confirmed that the asset purchase programme will be terminated in October, and signalled that later on in the year the operational guidelines for the reversal will be provided, taking into account the role played by money market funds and of the risks tied to them. The exit path remains dependent on the “outlook for the financial markets and the economy”, which is “never certain”. On this font as well, the assessment of risks is symmetrical: “if the labour market continues to improve more quickly than anticipated by the Committee […], then increases in the federal funds rate target likely would occur sooner and be more rapid than currently envisioned. Conversely, if economic performance is disappointing, then the future path of interest rates likely would be more accommodative”. These statements are in line with those made by Williams a few days ago: the FOMC is trying to induce the markets to consider macroeconomic data more carefully, and to price in some uncertainty in the outlook for fed fund rates.
– For what concerns the risks to financial stability, Yellen said that the Committee “recognises that low interest rates may provide incentives for some investors to ‘reach for yield’, and those actions could increase vulnerabilities in the financial system to adverse events”; one of the critical aspects monitored by the Fed is the issue of junk bonds and of debt-funded loans. In general, the Fed believes that the strengthening of the capital position of banks is helping to make the financial sector more solid and to reduce the risk of new systemic crises.
– According to the FOMC, a “considerable” period of time will pass between the end of purchases (October 2014) and the shift on rates: the length of this period will depend on the evolution of the macroeconomic scenario. Yellen’s words have not changed expectations for the reversal on rates to come around mid-2015. However, the consolidation of the recovery and the reduction of slack in the labour market may determine a steeper path for rates than currently anticipated by the Fed in its projections. Labour market data, and the wage trend in particular, will remain crucial. We confirm our forecast for a faster rise in rates than anticipated by the market, all along the 2015-2016 horizon.
Appendix
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