Federal Reserve Chair Janet Yellen has taken the mic after the Fed elected to raise interest rates for the first time since June 2006.
The Fed on Wednesday increased its target interest rate corridor to 0.25%-0.50% from 0%-0.25% exactly seven years to the day from when the Fed put its zero-interest rate policy in place during the depths of the recession.
In response to a question about why the Fed decided to raise rates now, Yellen said it’s important not to overemphasize the importance of this decision as the Fed is likely to raise rates gradually over time, though Yellen cautioned that these would respond to the economic outlook.
When pressed on why the Fed kept rates near 0% for so long, Yellen said the Fed was cognisant that were the economy to turn south in response to a too-early tightening of financial conditions, there would have been limited room for the Fed to act.
As for why raise rates now, Yellen said the “odds are good” the economy would have ended up overshooting the Fed’s employment, growth, and inflation goals were interest rates to remain pinned near 0% for too long.
Yellen said in prepared comments that with the economy performing well — and the Fed expecting these conditions to continue — the FOMC judged it appropriate to increase the Fed’s benchmark interest rate.
Yellen said the labour market has clearly shown “significant” further improvement towards the Fed’s objective of reaching full employment.
The economy has come a long way, according to Yellen, but further progress is still needed as the economy recovers from the worst recession since the Great Depression. As a result the Fed expects the increase in interest rates to be “gradual.” As for what gradual means, Yellen said this does not mean equally-sized and evenly-spaced interest rate increases over the coming years.
Yellen cited auto sales and personal spending as bright spots for the economy, adding that outside of drilling and mining business investment has posted “solid gains” this year.
On the inflation front, Yellen said that most of the shortfall in price increases from the Fed’s 2% target was due to a decline in oil prices and the strong dollar. Yellen called these influences “transitory” and said the Fed expects inflation will come up to its 2% target over the “medium term.”
As for why the Fed raised rates despite inflation coming in way below target, Yellen said that the Fed expects the aforementioned pressures from oil and the US dollar to abate while a tightening of the labour market should also push inflation higher.
Additionally, Yellen again said that the Fed could be forced to abruptly tighten policy were it to wait for inflation pressures to crop up only to find those pressures stronger than expected. Said another way, the Fed could find itself “behind the curve” and Yellen very clearly stated that the Fed does not want to be put in that position.
Yellen emphasised that she and other members of the FOMC have, over time, continued to declare that they have “reasonable confidence” that inflation will move towards the Fed’s 2% objective and today’s decision to increase interest rates affirms this belief. Yellen did add, however, that the Fed expects inflation to rise towards its forecast as growth and employment continue to improve. However, Yellen said that if this did not evolve as expected it would give the FOMC “pause.”
When asked about wage growth, Yellen said that an uptick in these numbers have been “incipient” but wouldn’t say that there is a lot of confidence in wage increases being a “firm” trend.
When asked why the Fed continues to believe oil will be a transitory factor — considering oil prices were at $60 in June and around $36 today — Yellen said the further decline in oil prices was a surprise, but said that the Fed simply needs to see oil prices stabilise for the negative impacts to inflation to roll off year-over-year comparisons. Yellen added that the Fed does not, therefore, need oil prices to rise for inflation to rise back to its target.
Yellen added that interest rates over the coming years are likely to be lower than what most FOMC members would judge to be appropriate for the Fed Funds rate over the longer-term.
Asked about whether or not the length of the current expansion was cause for concern, Yellen said she believes it is a “myth” that economic expansions die of old age. Earlier this year a few economists had said the chances of a recession were likely simply because the current economic expansion is entering its seventh year.
Yellen cautioned, however, that in any given year there is maybe a 10% chance that some external shock could send the economy into recession, but as it currently stands there isn’t anything, in Yellen’s view, that would cause this shock.
Yellen was also asked that while expansions may not end of old age but are often killed by central banks, Yellen said that central banks have often waited too late to begin tamping down inflation thus causing a decline in economic activity, a situation which, again, Yellen said the Fed is keen to avoid.
As for central banks that raised rates and have then been forced to cut them later, Yellen said the Fed has weighed that risk carefully and does not believe the Fed will need to do that. Yellen added, however, that the Fed will adjust its policy in “whatever way is necessary” to respond to economic conditions.
Asked about how the Fed might manage its $4 trillion balance sheet, Yellen said the Fed is “studying” what its longer-term plan might be for maintaining a balance sheet of a certain size. Yellen did note, however, that the Fed will seek to diminish the size of its balance sheet over time, but beyond this the future is unclear.
As for what else the Fed could do aside from buying assets, Yellen said that negative interest rates is something the Fed could study. The European Central Bank, we’d note, has had negative rates in place for over a year.
Recent news out of distressed credit markets, particularly the cessation of redemptions from Third Avenue’s Focused Credit Fund, prompted a question about the risk posed by this fund to the system to which Yellen said this fund was “unusual.”
As for what Americans can take away from this decision, Yellen said the decision to raise rates reflects the Fed’s confidence in the US economy and one that is on the path to “sustainable improvement.” Yellen added that she hopes Americans will take this one that signals the Fed’s confidence that labour market conditions will also continue to improve.
Businesses, Yellen noted, could see interest payments increase as some loans are tied to the Fed’s prime rate, which will increase as Wednesday’s Fed announcement also resulted in the discount rate rising from 0.75% to 1%.
Most all economists on Wall Street had expected the Fed to raise rates and following the announcement markets were, all things considered, fairly sanguine about the news.
Following the Fed’s announcement, stocks were higher with the Dow up about 200 points while Treasury yields were also higher but not hugely as the 2-year yield again broke above 1% after doing so earlier in the morning.
Crude oil remained down about 3.5%.
This post is being updated.