Testimony by Federal Reserve Chair Yellen is one of this week’s few highlights. Yellen’s testimony is not about articulating a new policy, but explaining the existing policy to US Congress, and to some extent, the American people.
The key point is that monetary policy is in transition. The asset purchases have stopped, though the maturing issues continued to be reinvested. The Federal Reserve is preparing the market for a rate hike, though it is not indicated when, though it has thus far used word clues to indicate that it will not happen in March or April. We expect Yellen not to say anything that will rule out a June hike.
Yellen will likely make four important points for investors. First, the decline in measured inflation due to the drop in energy prices will be transitory. This means that the low inflation readings are being de-emphasized. Second, she will likely point to the fact that unemployment continues to fall faster than the Federal Reserve anticipated.There is still scope for additional cyclical improvement.Third, the Fed it is demonstrating its patience. Fourth, Yellen can be expected to defend the Fed’s record and seek to blunt a legislative encroachment of the central bank’s independence.
The Federal Reserve will not raise rates at the March 17-18 FOMC meeting. Nevertheless, it will provide significant insight into the timing of its first rate hike since the Great Financial Crisis. All the crunching of the economic entrails and the hours of analysis comes down to a single word: patience.
The Fed uses its statements to guide investor expectations as economic conditions evolve. Previously the Fed had indicated there would be a “considerable period” between the end of its asset purchase program (QE3) and the first rate hike. Last December, the Fed statement introduced the concept of “patience” before raising rates.
The Chair of the Federal Reserve Janet Yellen was pressed to define what patience meant, and she ultimately settled on a “couple” as in two meetings. Given that there are two meetings a quarter, the use of the forward guidance in December signaled no rate hike in Q1 15.
