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Fed’s Yellen says case for interest rate hike has strengthened

Federal Reserve Chair Janet Yellen attends a news conference after chairing the second day of a two-day meeting of the Federal Open Market Committee to set interest rates in Washington

The case for a US interest rate hike has strengthened in recent months because of improvements in the labour market and expectations for solid economic growth, Federal Reserve Chair Janet Yellen said on Friday.

Yellen did not indicate when the US central bank might raise rates, but her comments reinforced the view that such a move could come later this year. The Fed has policy meetings scheduled in September, November and December.

Speaking at a three-day international gathering of central bankers and academics in Jackson Hole, Wyoming, Yellen said the “US economy was nearing the Federal Reserve’s statutory goals of maximum employment and price stability.”

Data released earlier on Friday, however, showed the economy was more sluggish than initially thought in the second quarter, with gross domestic product expanding at a 1.1 per cent annual rate. At the same time, consumer spending, which makes up more than two-thirds of economic activity, grew at the fastest rate since the fourth quarter of 2014.

Yellen pointed to a recent rebound in employment and said the Fed expects the economy to continue expanding.

“In light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,” Yellen said, adding that the Fed still thinks future rate increases should be “gradual.”

The Fed raised rates in December, its first hike in nearly a decade, but it has held off further increases so far this year due to a global growth slowdown, financial market volatility and generally tepid US inflation data.

Yellen did not lay out a clear roadmap for what the Fed needs to see to raise rates. Investors have been doubtful about the central bank’s guidance, in part because its policymakers appear to be divided over whether to hike rates soon or take a more cautious approach.

“She’s just kept the door open for a hike sooner rather than later,” said Subadra Rajappa, an interest rate strategist at Societe Generale in Washington.

Prices for fed funds futures implied investors saw about even odds that the Fed will raise rates in December, largely unchanged from before Yellen‘s remarks. Investors see much smaller chances of hikes in September or November.

The dollar jumped against the yen and euro on Yellen‘s remarks before turning lower. US stocks briefly pared gains, while prices of longer-dated US Treasuries were trading higher.

Yellen noted that Fed officials have a wide range of views on where rates will likely be in the coming years. She said current forecasts imply a 70 per cent probability they will be between 0 per cent and 3.75 per cent at the end of 2017, and a 70 per cent probability they will be between 0 percent and 4.5 per cent at the end of 2018.

Such uncertainty, she said, is inherent in the inability to predict economic shocks.

OTHER OPTIONS

Yellen was speaking at a Fed conference on designing new monetary policy frameworks, with central bankers eager to find new ways to stimulate economies even after they have cut rates to near zero and flooded banks with money.

She devoted much of her speech to outlining how the Fed may deal with future recessions now that many economists and Fed officials believe that an aging population and other dynamics appear to be slowing US economic growth over the long term.

Because slower growth means future US interest rates will likely also need to be lower on average, some analysts have suggested that the Fed will have less room to fight future recessions because there will be less room to cut rates.

Such a view is “exaggerated,” Yellen said, because the Fed will be able to use bond purchases and forward guidance to ease conditions. She said the Fed still planned in the future to wind down its massive balance sheet but that it would take time, adding that the balance sheet was likely to be useful for policy for some time.

The Fed may also want to explore other options, including broadening the range of assets it can purchase, raising the inflation target, or targeting nominal GDP, she said.

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