Forex Trading Library

Yellen signals a cautious approach to rate hikes

1 431

The much-awaited speech by Janet Yellen yesterday saw the Federal Reserve Chairwoman defend the Central Bank’s decision on moving gradually on interest rate hikes given the uncertainty across various factors. She also outlined the tools the Fed could use if the US economy shows signs of slowing down.

In her speech, Ms. Yellen said that “global developments have increased the risks” to the global outlook, and those financial conditions were less favorable than they were in December when the Fed hiked rates by 25bps. Ms. Yellen said that given the risks, “I consider it appropriate for the Committee to proceed cautiously in adjusting policy.” Ms. Yellen, however, declined to comment on when the Fed could hike rates next, a question widely asked after Fed’s Williams said that rates could be hiked as early as April.

Ms. Yellen’s dovish remarks yesterday were welcomed as the equity markets posted gains as Treasuries fell. The S&P500 Index closed at a 10-week high yesterday at 2057 following Ms. Yellen’s comments, while the 10-year Treasury fell to 1.81%, following a brief rally to 1.97% earlier in March. The dovish comments also sent the US Dollar Index weaker, which fell -0.82% to settle at 95.81, erasing over 60% of the gains made last week. The US Dollar Index touched a low of 94.77 a week before after the FOMC’s March meeting where interest rates were left unchanged, and the Fed’s monetary policy statement was dovish.

US Dollar Index (ICE) – 30/03/2016
US Dollar Index (ICE) – 30/03/2016

Many expect no hike in April with the Fed funds futures showing a probability of only 7.0% while June rate hike probability has fallen to near 30%. The Fed Chairwoman said the overall fallout from market turmoil in the first seven weeks of 2016 will most likely be limited, but expressed doubts on the same.

On the recent pickup in inflation, especially in January, Ms. Yellen said not to read too much into the data and remained doubtful whether it was the start of a new upwards trend in inflation. The PCE Price index, which is the Fed’s preferred gauge of inflation, increased 0.10% in February, at a slower pace after January’s reading increased to 0.30% on a month over month basis, following an upward revision to December and November PCE data. Ms. Yellen said that “It is too early to tell if this recent faster pace will prove durable.”

Talking about the uncertainty, Ms. Yellen used yesterday’s opportunity to remind the markets that the Fed had tools to steer monetary policy in the event the US slipped into recession given the fact that interest rates were so close to zero bounds. She said that the Fed would have considerable scope to offer an accommodative monetary policy to stem the tide. Making use of forward guidance, Ms. Yellen said that the Fed could purchase even more bonds or exchange the short-dated bonds for longer-term bonds. A move that was seen in the aftermath of the 2008 global financial crisis which made the Federal Reserve to launch Quantitative easing, which expanded the Fed’s balance sheet by over $3 trillion. However, surprisingly there was no mention of negative interest rates in her speech in this context.

The full speech of Ms. Yellen at the Economic Club of New York, given yesterday can be accessed here.

Leave A Reply

Your email address will not be published.