Fed: Yellen Testimony Redux

Published on February 27, 2014

Fresh from her star turn in Sydney to ease G20 country anxieties over the Fed’s taper, Federal Reserve Chair Janet Yellen is unlikely to offer much in the way of surprises when  makes her return to Capitol Hill later this morning for her rescheduled testimony before the Senate Banking Committee.

*** The Fed Chair is likely to stick to a three part messaging: continued confidence in the recovery’s underlying momentum that, despite the recent softening in data, should still keep it on a 3% plus pace this year; the measured taper will be maintained with a high bar to either pausing or accelerating, and; the lower for longer rates “well past” the headline unemployment rate crossing the 6.5% threshold remains the key takeaway to the evolving forward guidance. ***

***  In other words, Yellen is unlikely to drift too far from the testimony provided earlier this month before the marathon House Financial Services session, and the reasons are twofold: the recent data, while looking soft for sure, are still far more noise than signal, making it too soon warrant a downshift in the outlook, and two, if she did open the door to an even more dovish turn, there is no consensus yet within the Federal Open Market Committee to back it up or on what to do about it. ***

Familiar, and New, Questions

Yellen will be presenting the same written testimony to the Banking Committee she did on the House side, so the interest will center on her answers to the questions from the 22 Committee members.

Many of the questions will sound familiar. She is likely to be asked what the FOMC intends to do with its forward guidance now that the unemployment threshold is nearing its sell-by date. A fair question, to be sure, but Yellen is unlikely to go into much detail beyond that emphasis on the “well past” supplement to the Numerical Thresholds, which she will note have served a very useful purpose in guiding expectations up to now, and that “clarity” on the Fed’s reaction function will be forthcoming.

Yellen is likewise likely to draw question or two of how soon the threshold will be crossed and more questions on the Fed’s read of the structural versus cyclical reasons for the falling labor participation rate, to which she is likely to reaffirm it looks mostly demographic and structural but that it doesn’t preclude a highly accommodative policy until a wider array of labor market data points to a healthier job creation, wage growth, and aggregate demand.

But two issues may get more play than in the House testimony. The first is the degree to which the financial stability issue is rising to the forefront rather than higher inflation as a primary policy concern. On that front, Yellen is very likely to hue close to the thoughtful and thorough speech on the subject by Governor Tarullo on Tuesday: she is likely to accent how the Fed is closely monitoring financial market developments, highlight the bank stress testing, and how macro-prudential is the primary defense against a repeat of financial instability.

It will be very interesting, though, to see how far she goes in echoing Tarullo — and Governor Stein, who speaks on Friday on the financial stability issue — in cautioning that rate increases should be “kept on the table” to get into those cracks of the financial system to deter asset bubbles and a dislocative reach for yield.

The second is the ominous persistence in low inflation well under the Fed’s mandate consistent 2% target rate over the medium term. Yellen is likely to echo previous remarks that the various measures of inflation should steadily rise this year to as much as 1.8% this year and back to the 2% target next year. That, however, is what they said last year, and it is getting hard for the Fed not to notice the global nature of the deflationary pressures; recent visits to counterparts in Frankfurt have found the same sense of concern.

In any case, the headlines Chair Yellen will be seeking is a continuity of the current policy path that, in some sense, makes it hard for her to be even more dovish than the Fed already is, certainly before there is further clarity on the outlook. Better instead for now to seek shelter behind the cold and noisy data and leave any shifts in the forecasts and messaging to her first chairing of the FOMC at their meeting in three weeks.

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