Fed: Not Yet

Published on July 14, 2014

Those hoping to see Federal Reserve Chair Janet Yellen signal a hawkish turn tomorrow when she testifies on Capitol Hill Tuesday and Wednesday are likely to be disappointed.

While we expect Chair Yellen to indicate a cautious optimism on the post first quarter outlook, and we do think the balance of the sentiment within the Federal Open Market Committee is starting to slowly tilt towards a tilt to upside risks, our sense is that it is just too early for the Chair to signal a Committee consensus in that direction for now.

For one, the Humphrey Hawkins testimonies before the Senate Banking Committee and the unwieldy House Financial Services are less than ideal forums to convey nuanced policy messaging aimed at the markets. In addition, the Chair is speaking on behalf of the current FOMC consensus as of its most recent June meeting. So even if she wanted to – which she doesn’t – Chair Yellen is very unlikely to indicate any notion the central bank is nearing the “lift-off zone.”

The data, while picking up, is still far short of an all clear on the degree of labor market slack Chair Yellen and a majority of the FOMC believe is still keeping unemployment well short of its longer run trend levels, and inflation, while modestly ticking up in the most recent prints, remains short of its mandate-consistent levels. Most of all, that freefall in the first quarter is still leaving most of the FOMC wanting to see quite a bit more evidence of the economy on a near 3% growth glide path.

We do think the Committee is nevertheless getting more optimistic the worst is in the rearview mirror, perhaps including the concerns earlier this year over the persistence in low inflation – which we have to say would be a big step if she did indicate just that in the two days of testimony.

But most of that guarded optimism is building off the back of the most recent data since the mid-June FOMC meeting. So while the Chair acknowledges the modestly better data, she is more likely than not to steer clear of a hawkish-sounding all clear even as she lays out the internal work on revamp to the June 2011 Exit Principles. In other words, hikes are coming, but there remains uncertainty on its timing until the data moves further along in feeding into the forecasts on growth, the health of the labor market, and the behavior in inflation.

Chair Yellen may also get testing questions on the inflation dangers of the Fed’s massive balance sheet or even pointed questions on the need for a more rules-based monetary policy along the lines of the House Financial Services hearing last week. But since few if any of the Members of the House Committee have any idea what that debate is actually about or how to follow through on the question, we suspect the Chair will easily dance around the issue, perhaps saving it for a much later day.

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