New Signals from the Fed
Ahead of the November 2 meeting of the Federal Reserve Open Market Committee, Chairwoman Janet Yellen is suggesting that “high pressure” policies may be needed to keep the economy moving forward.
She made these remarks on Friday, while speaking at a lunch meeting of influential policymakers and academics. In trying to answer questions about the recovery, and where it may have fallen short, Yellen appeared distraught at the growth potential of the U.S. economy. (Source: “Fed’s Yellen says ‘high-pressure’ policy may be only way back from crisis,” Reuters, October 14, 2016.)
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Yellen stressed that adverse impacts from the 2008 financial crisis had not fully been addressed—namely those on discouraged workers and long-term output. She argued that aggressive action may be needed to prevent these conditions from becoming permanent.
Yellen mused about solving this crisis “by temporarily running a ‘high-pressure economy,’ with robust aggregate demand and a tight labor market.” In part, this could mean keeping interest rates below their historical averages as inflation rises past the Fed’s two-percent threshold.
“One can certainly identify plausible ways in which this might occur,” she said.
Although Yellen was speaking in a mostly hypothetical tone, her comments are scrutinized by Wall Street. She is keenly aware of this fact, meaning that all her public appearances are carefully parsed to soften their impact on markets.
As such, her musings should be taken seriously. If the Fed does not aggressively raise interest rates once the two-percent ceiling is breached, it would seriously change the complexion of medium-term interest rates. However, most analysts still think a December rate hike is on the horizon.
Despite the surge in bond prices after Yellen’s comments, the FedWatch tool still shows an approximately 75% chance of higher rates before the end of the year. Markets have been primed for a slight bump in interest rates, plus it would serve as an acknowledgement of unemployment falling below five percent.
But that does not mean markets expect the Fed to continue raising interest rates beyond the 50 to 75 basis points range. Yellen refused to put away the crisis management toolkit, saying those tools, “may be needed again in the future, given the likelihood that the global economy may continue to experience historically low interest rates, thereby making it unlikely that reductions in short-term interest rates alone would be an adequate response to a future recession.” (Source: Ibid.)
