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Yellen Talks Up Rate Hikes Again, US Markets Drift

Posted by Joseph Trevisani on Jul 15, 2015 12:59:00 PM

Federal Reserve Chair Janet Yellen said the chances for a rate hike this year are good if the economy improves as the bank predicts. 

"If the economy evolves as we expect, economic conditions likely would make it appropriate at some point this year to raise the federal funds rate target,” Ms Yellen said in prepared remarks Wednesday before the House Financial Services Committee in Washington, D.C. today.

Market reaction to Ms Yellen' statement was muted. She and other Fed officials have offered the same analysis on many other occasions over the past year.

Ms Yellen emphasized, as before, that the timing and fact of the first rate rise in nine years is less important than the subsequent path of increases. Higher rates would come slowly and an accommodative monetary policy will continue to be appropriate for a considerable time.

In stressing the gradualist approach, Ms Yellen is most likely trying to preclude a rapid surge higher in rates. In the middle of 2013 the ‘taper tantrum’ response to then Fed Chairman Bernanke’s hint that the quantitative easing program could be phased out, drove the 10-year yield from 1.63 percent in early May to 2.74 percent in July and 3.00 by the first week of September

Ms Yellen noted that Fed forecasts for higher rates this year are projections and “not statements of an intent to raise rates at any particular time," though she said that an increase is possible at any FOMC meeting for the rest of the year.  The next meeting is July 28th and 29th

Today was the first of two scheduled days of testimony before Congress, tomorrow Ms Yellen will appear before the Senate Banking Committee. The Fed Chair repeated that the Fed will tighten policy when it sees further improvement in the labor market and is “reasonably confident” that inflation is headed toward the bank's 2 percent target.

The central bank can point to noticeable progress in the labor market. Non-farm payrolls have averaged 245,000 a month in the year to June the best run in 15 years and the unemployment rate has fallen to 5.3 percent, its lowest since early 2008.

But behind both statistics are more troubling circumstances. Wages have not kept pace with jobs. Average hourly earnings have been essentially flat since the end of the recession in June 2009, barely outpacing inflation.  The lack of wage growth has been reflected in the anemic retail sales numbers, which have averaged about half the annual increase since the beginning of 2009 as compared to before the recession.

Likewise the decline in the unemployment rate has largely been the product of workers exiting the job market and no longer being counted as unemployed by the Labor Department, rather than by a large influx of formerly unemployed workers finding new jobs.  

Inflation has been quiescent with no discernable trend higher. The annual increase in the core consumer price index, excluding food and energy costs, was 1.7 percent in June, exactly its average for the year so far and for the last 18 months.

The Fed’s preferred inflation gauge, the core personal consumption price index was even lower at 1.2 percent annually in May, just under its 18 month average of 1.4 percent.    

Sentiment in the credit, equity and currency markets was unchanged by the Fed Chair's comments. 

The yield on the US 10-year generic Treasury fell five basis points to 2.35 percent, its lowest rate this week. The 2-year yield slipped one point to 0.62 percent and the yield on the 30 year bond dropped six points to 3.13 percent.

The dollar rose marginally against the euro, trading at 1.0943 in the afternoon in New York. The united currency had been as high at 1.1036 in Europe. The euro decline was probably due more to uncertainty over the still incomplete Greek bailout than any incipient U.S. rate increase.  

Equities were also down slightly on the day. The Dow closed down just 3.41 points at 18,050.17. The S&P 500 and the NASDAQ were also fractionally lower.

The Fed’s anticipation that stronger economic growth in the second half will enable its rate hikes enters an atmosphere of declining expectations for U.S. GDP.

At last month’s FOMC meeting the Federal Reserve released GDP projections for the U.S. economy in 2015 that had been cut by almost 25 percent. The central tendency for annual economic growth dropped to 1.8-2.0 percent from 2.3-2.7 percent.  

Annualized growth in this year’s first quarter was -0.2 percent and is tracking at 2.4 percent in the second quarter, according to the Atlanta Fed's GDPNow estimate.  If those figures maintain the U.S economy would have to expand at 2.7 percent in the second half of the year to reach 1.9 percent for the entire twelve months.  

In 2014 U.S. GDP averaged 2.4 percent for the year but was very uneven quarter to quarter. The economy contracted at a 2.2 percent rate in the first quarter, reversed to 4.6 percent and 5.0 percent in the second and third quarters and then fell by half in the last three months to 2.2 percent.

In the past five years and one quarter the U.S economy has averaged 2.2 percent GDP expansion: 2010 2.7 percent; 2011 1.7 percent; 2012 1.6 percent; 2013 3.1 percent; 2014 2.4 percent; Q1 2015 -0.2 percent.

 

Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

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