Thursday, July 13, 2017

The Caution Light Blinking In Yellen's Testimony

Appearances this week by two Fed officials give insight into the push for rate increases -- not too many, and not too fast.


By Daniel Moss
The Bloomberg View
July 13, 2017

The retreat of inflation and lack of meaningful wage growth are becoming increasingly dominant in the Federal Reserve's deliberations.

Near the center, literally, of Fed Chair Janet Yellen's five-and-a-bit pages of written testimony to Congress was an acknowledgment that officials just don't know when the current very low levels of unemployment will translate into a spurt in pay.

Yellen implied, by ranking the issue above global growth and the economy's overall performance, that the pay-prices conundrum is now number one on the Fed's watch list: "Of course, considerable uncertainty always attends the economic outlook. There is, for example, uncertainty about when--and how much--inflation will respond to tightening resource utilization."

It should have happened by now, in theory. The jobless rate is 4.4 percent, and employers are still adding about 200,000 jobs a month. It sounds as though the Fed is about to hit the pause button on interest-rate increases, at least for a bit. Yellen said the Fed may not have that much more work to do to return interest rates to a neutral level, to neither stimulate nor dampen economic life.

Perhaps tellingly, Yellen declined in written testimony to describe the retreat in inflation as temporary or transitory, two words officials have often used to explain why they proceeded with rate increases in the face of receding price pressures. She did call reductions in some price areas "unusual." Later, under questioning from Representative Carolyn Maloney, she used "transitory.''

The Fed's preferred measure of inflation, the Personal Consumption Expenditures index, slipped to 1.4 percent in May, the most recent figures available. The Fed targets 2 percent. The index has been receding since reaching 2.1 percent in February. Until that month, the gauge hadn't been at target since 2012.

Now that we've seen Yellen's perspective, let's take another look at the Tuesday speech from a Fed governor. Lael Brainard, seen as a leader of the central bank's dovish wing, suggested the decline in inflation deserves a lot more scrutiny.

In an address at Columbia University, Brainard said she wants "to assess the inflation process closely before making a determination on further adjustments to the federal funds rate in light of the recent softness" in inflation. In case the point was missed, later in the same paragraph she reiterated: "I will want to monitor inflation developments carefully, and to move cautiously on further increases."

Brainard made the case for Fed restraint in 2015 and 2016 in response to international softness, but was on board with rate increases in March and June as the global picture strengthened. Because she is not reflexively dovish, her conclusion this week is especially interesting.

By the way, Brainard also said that the neutral level of the Fed's benchmark rate may not be far off. If so, most of the heavy lifting is done.

(Brainard and Yellen struck a somewhat different tone on when to begin balance sheet reduction, but that's another story.)

Yellen wasn't all downbeat in her report to Congress. She lauded the global expansion and pointed to signs the pace of U.S. growth picked up last quarter. The housing market continues to recover steadily, and consumer spending is supported by strong payrolls growth.

And, yes, further gradual rate increases will probably be needed over the next few years. But the sense this week is that "neutral" may not be too far away.


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