Yellen’s Fed in the name of continuity. Tapering to continue. New, more qualitative forward guidance due soon, tying the path of policy rates to inflation and slack. …
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– In her first testimony as Fed Chairman, J. Yellen began with a premise, declaring her commitment to follow up on the work done by Bernanke, who “helped make our economy and financial system stronger, and ensured that the Federal Reserve is transparent and accountable”. The hearing centred on two main aspects. First of all, a “methodological” characterisation of the strategy: monetary policy will be defined by “a great deal of continuity”, guided by a commitment to “achieving both parts of the Fed’s dual mandate” (maximum employment and price stability), and will be managed in a markedly collegial manner (Yellen used a formula to stress the importance of this aspect: “my colleagues on the FOMC and I”).
– Yellen then moved on to the more substantive aspects, i.e. the guidelines of the Fed’s action in the near future and beyond. As regards the evolution of the economic cycle, Yellen’s assessment of the scenario was positive, and focused on the acceleration in growth and the resulting, further improvement of labour market conditions in the second half of 2013.
However, as expected, Yellen said that the recovery in the labour market “is far from complete”, and that there is still work to do on this front, with an unemployment rate still above its long-term average, and a very large share of workers that have been out of a job for more than six months, or are working part-time for economic reasons. Yellen reasserted the need to consider other indicators in addition to the unemployment rate to adequately assess labour market conditions. For what concerns the growth outlook, an important point for Yellen is the smaller degree of fiscal consolidation compared to recent years, in order to fuel the positive growth trends of consumption and non-residential investments. As a result, forecasts are confirmed for moderate growth in 2014-15, with unemployment on the decline and inflation gradually returning towards 2%; recent volatility on the financial markets is not considered for the moment as a “substantial risk” for the US.
– As regards monetary policy, continuity in the FOMC’s approach is of the essence. Tapering will go on: only truly radical changes to the scenario could lead to a change in course with regards to QE3. The asset purchase programme will be reduced in further “measured steps”, if the labour market continues to improve and inflation to normalise. As for rates and guidance, Yellen repeated that achievement of one of the thresholds (in particular the 6.5% unemployment rate threshold) does not imply a rate hike by the FOMC, but only that it will start to consider the opportunity of a hike. Also, Yellen reasserted that the FOMC will probably consider it appropriate to keep rates stable even well beyond reaching the 6.5% threshold, especially if forecast inflation stays below 2%.
– The reformulation of guidance is undoubtedly at the top of the FOMC’s agenda now, and indications on this front could come already with the minutes of the January meeting, due to be published next week. On occasion of the March meeting, that will be followed by a press conference, we expect a new, more qualitative formulation to be presented, with less importance attached to the absolute level of the unemployment rate. Guidance could place more emphasis on the persistence of the inflation rate below 2%, and include explicit reference to other labour market indicators. In particular, in addition to the duration of unemployment, measures of underemployment, and information on labor flows, the FOMC could give explicit weight to the unemployment gap, the difference between the actual and the long-term unemployment rates (currently estimated by the Fed at between 5.2% and 5.8%). The Fed’s new guidance could therefore be similar to the one given this week by the BoE, which is now tying the policy rate path to the size of unused resources, and to other labour market indicators in addition to unemployment, in a context of low inflation. In our view, the FOMC’s indications will remain markedly dovish on rates, even in the event of further, rapid declines of the unemployment rate.
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