The Federal Reserve did little to dispel confusion over US monetary policy as Fed Chair Janet Yellen yesterday stood firm with her dovish stance in the face of a rising number of hawkish voices from within the FOMC. Speaking at the Economics Club of New York, Yellen reiterated the need for caution despite several Fed officials last week expressing their confidence that the US economy is strong enough to withstand at least two more rate hikes this year.
In the speech, aptly titled “The Outlook, Uncertainty, and Monetary Policy”, Yellen explained in detail why caution was appropriate in the current economic environment, while at the same time making it clear that the FOMC was not on a preset course. Repeating the downside risks outlined in the March FOMC statement, Yellen emphasized the dangers to the US economy from the weaker outlook for the global economy.
The US economy has so far remained resilient to global events such as the slowdown in China, stock market volatility and the slump in oil prices. However, Yellen warned that no one can be certain about the pace at which economic headwinds will fade, and should the downside risks materialize, they would likely lead to a slowdown in US economic growth. Yellen concluded therefore that “developments abroad imply that meeting our objectives for employment and inflation will likely require a somewhat lower path for the federal funds rate than was anticipated in December”.
With regards to inflation, Yellen was less optimistic than some of her colleagues who recently sounded more upbeat on the price outlook. Yellen said it was too early to tell if the recent unexpected pick-up in the core PCE price index to 1.7% will prove “durable”. She also sounded worried about the decline in inflation expectations in some indicators of expected inflation. However, she was also quick to point to the upside risks of inflation recovering sooner than expected.
The renewed concerns about the health of the global economy and on the inflation outlook have prompted the Fed to backtrack from its stance in December when it stressed the need to stay ahead of the curve by raising rates early but gradually. The Fed is now willing to risk inflation running a little ahead as it has more room to respond to upside risks than downside risks, given that interest rates remain near rock bottom levels. Interestingly, Yellen was keen to highlight other measures the FOMC would be able to deploy to provide additional accommodation similar to those used during the financial crisis, but these did not include negative interest rates.
As expected, the dollar reacted negatively to Yellen’s cautious tone, retracing almost all of its gains since the FOMC meeting in mid-March. The dollar index fell around 1% yesterday, extending its slide further on Wednesday. The greenback was back below 113 versus the yen, while the euro rose above 1.13 dollars for the first time since March 18. Gold was one of the biggest beneficiaries of the dollar sell-off as the yield on 10-year US treasures fell from around 1.85% to just above 1.80%. This triggered a near 1.5% jump in the price of gold to $1243 an ounce as the decline in longer-term interest rates increases the attractiveness of the precious metal.
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