Reflections on Yellen’s Press Conference

September 21, 2016

Markets reacted well. Shortly after the end of the press conference and some 95 minutes after the release of the FOMC statement and forecasts, the 10-year Treasury yield over the whole span of that time was four basis points lower than at the start of the period. U.S. share prices had risen 0.7%, and the dollar had softened by 0.4% against the yen and 0.25% relative to the euro; a weaker dollar is a more competitive dollar and helps lift inflation as Fed officials seek.

Yellen made several points especially worth remembering.

  • Any disagreement among committee members on the federal funds rate involves timing rather than the premise that it should be lifted eventually.
  • The perceived neutral real federal funds rate keeps falling. So has the estimated long term growth rate. Weak productivity growth, which is expected to continue, is a major reason why.
  • There was a stronger case for increasing the federal funds rate than when the committee met previously in late July. ┬áBut there is no indication that the economy is overheating.
  • FOMC members are happy to see the recovery enticing workers on the sidelines to reenter labor force and find jobs. It’s a trend that they’d like to encourage amid wage and income growth that’s still historically low and given continuing sub-target inflation.
  • The risk of raising interest rates more slowly than optimally appropriate and thereby heating up the economy more than desired must be balanced against the risk of not getting back to 2.0% inflation should monetary policy move too aggressively. The drop in some measures of expected inflation has been unexpected and needs monitoring. The process by which excessive inflation develops may be different now than in the 1970s.
  • It’s imperative that the Fed avoid any appearance of allowing bipartisan politics to enter its discussion or decision-making. Yellen fended off many questions tied to the coming U.S. election, even one that noted that it factored in the possibility of Brexit as a risk earlier this year but hasn’t mentioned anything about the presidential election.
  • The Wells Fargo scandal elicited several questions about bank supervision. Yellen wouldn’t agree that a bank like Wells had become too large to be managed properly in such a way that practices that endanger consumers can be avoided.
  • All FOMC meetings are live ones in that it is possible for officials to change the federal funds rate if sufficient change in economic trends or expected trends warrants such. ┬áThat includes the next meeting in November just days before the election. Yellen and her colleagues believe strongly that because monetary policy impacts only after long and variable lags that decisions must rely on forecasts and not wait until an unacceptable change in trend has become clear and present.
  • She is not bothered by the diversity of opinions expressed when different policymakers on the committee publicly state their own views. It’s a sign that the committee doesn’t suffer from “group-think” and helps flesh out the texture of the committee’s thinking on very complex matters.
  • While she doesn’t consider asset valuations as generally out of line, she mentioned commercial real estate as one area to be watched.

The biggest take-away, repeated often in the press conference, is that there is little sign that the U.S. economy is overheating. Consequently, the process of policy normalization is likely to be gradual, so gradual indeed that any thought to hike rates by as much as 50 basis points as a way of gaining a rate cushion more quickly for responding to the next recession is not an option getting traction.

Copyright 2016, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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