In her testimony to the House Financial Services Committee, Fed Chair Janet Yellen spoke about the growing risks to the US economy in her first public statement since the December rate hike. While maintaining the Fed’s outlook that the economy will continue to grow at a moderate pace and inflation will return to the 2% objective in the medium term, Yellen stressed that monetary policy was not on a “preset course”.
Pointing to the recent falls in equity prices and the dollar’s appreciation, Yellen said financial conditions have become “less supportive of growth”. Should these conditions persist, the outlook for economic activity and the labor market would deteriorate. In her statement, Yellen also spoke about the recent market volatility, making specific reference to China. Yellen appeared to link the volatility to the uncertainty created by China’s exchange rate policy. She also warned that financial market conditions could tighten further if the downside risks from the recent global developments materialized.
The Fed is not expected to publish revised inflation projections before the March FOMC meeting but Yellen acknowledged that longer-run inflation expectations have declined slightly since the December rate hike. She maintained however, that low inflation was due to transitory factors and inflation should move up towards 2% as the labor market continues to improve.
Yellen also repeated the position from the January FOMC statement that the Fed is closely monitoring global economic and financial developments and that the actual path of the federal funds rate will depend on the incoming data. Although the recent developments could weigh on US economic outlook, Yellen said she does not expect interest rates to go down anytime soon.
Interestingly, when questioned about negative interest rates in the question and answer session, Yellen explained that although further study is needed about the legality of implementing negative rates in the US, she did not think it was required at present. However, it is clearly a tool that the Fed may consider in the future as it has included the scenario of negative rates in its upcoming bank stress tests.
The dollar rose against major currencies soon after the testimony started as there was little in Yellen’s statement to rule out a rate hike in the coming months. But the greenback receded to levels before the statement as Yellen maintained a cautious tone during her question and answer session, reiterating that monetary policy will remain accommodative with only gradual increases in the fed funds rate.
The euro touched a low of 1.1160 dollars before rebounding to around 1.1240 dollars in afternoon US session. Against the yen, the greenback briefly rose above 115 yen but later lost ground, hitting a low of 113.73 before settling around 114 yen. Cable was steadier, edging up just above 1.45 dollars.
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