There really weren’t any surprises in Fed Chair Janet Yellen’s semiannual congressional testimony and report on monetary policy yesterday. She signaled that while the normalization of monetary policy might begin around mid-year, the FOMC is likely to do so very gradually. Both stock and bond prices responded positively. The S&P 500 rose to 2115, another record high. The Nasdaq rose to 4968, only 1.6% below its record high of 5048 on March 10, 2000. Let’s review what she had to say:
(1) Labor market. Fed policy remains dependent on “incoming data.” Despite the awesome employment report released on February 6, Yellen said in her prepared remarks that “a high degree of policy accommodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term.”
(2) “Patient.”. She didn’t say when or under what conditions the word “patient” would be deleted from the FOMC’s forward guidance. However, she reiterated that the “FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings.”
This does suggest that the word could be dropped from the March 18 statement if the FOMC anticipates liftoff at the June 16-17 meeting. I still think the FOMC might keep the word, but change its context to suggest that the Fed will be patient about raising interest rates further after the first rate hike.
(3) Normalization. Now, I challenge you to decipher the following from Yellen’s prepared remarks, which seems to have been written in Greenspan-speak:
(1) Labor market. Fed policy remains dependent on “incoming data.” Despite the awesome employment report released on February 6, Yellen said in her prepared remarks that “a high degree of policy accommodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term.”
(2) “Patient.”. She didn’t say when or under what conditions the word “patient” would be deleted from the FOMC’s forward guidance. However, she reiterated that the “FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings.”
This does suggest that the word could be dropped from the March 18 statement if the FOMC anticipates liftoff at the June 16-17 meeting. I still think the FOMC might keep the word, but change its context to suggest that the Fed will be patient about raising interest rates further after the first rate hike.
(3) Normalization. Now, I challenge you to decipher the following from Yellen’s prepared remarks, which seems to have been written in Greenspan-speak:
If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.
The main point seems to be that the FOMC might continue to normalize monetary policy even if inflation remains below 2%, as long as the committee expects it will move back up there in a reasonable time.
However, the federal funds rate is likely to remain below “normal” for quite some time:
However, the federal funds rate is likely to remain below “normal” for quite some time:
It continues to be the FOMC's assessment that even after employment and inflation are near levels consistent with our dual mandate, economic conditions may, for some time, warrant keeping the federal funds rate below levels the Committee views as normal in the longer run. It is possible, for example, that it may be necessary for the federal funds rate to run temporarily below its normal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity
(4) Bubbles. In her prepared remarks during her previous semiannual testimony on July 15, 2014, Yellen mentioned that she had some concerns about speculative excesses as some investors “reach for yield.” She didn’t mention that this time. However, the formal report observed:
Overall equity valuations by some conventional measures are somewhat higher than their historical average levels, and valuation metrics in some sectors continue to appear stretched relative to historical norms.
There was no specific mention of stretched valuations for smaller firms in the social media and biotechnology industries, as there was in the July 2014 report. Back then, overall valuations seemed consistent with historical norms for the prices of real estate, equities, and corporate bonds
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