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Yellen’s Humphrey Hawkins: cautious policy, reiterated
Chair Yellen’s prepared remarks
Chair Yellen’s semi-annual Monetary Policy Report to the Congress (Humphrey Hawkins) did not break new grounds. Testifying at the Senate Committee on Banking, Housing, & Urban Affairs, the Fed Chair reiterated that the “FOMC continues to anticipate that economic conditions will improve further” to warrant gradual normalization of monetary policy, but she also re-emphasized factors supporting a cautious policy path amid macro uncertainties:
- The Fed will carefully monitor data to assess whether the recent slowing in employment growth is transitory (which is the Fed’s base-case scenario)
- Business investment outside of the energy sector was surprisingly weak (this topic received considerable attention during the testimony)
- Soft readings on labor market and weak pace of investment illustrate the downside risk of faltering domestic demand
- Slow productivity growth seen in recent years may continue into the future
- Vulnerabilities in the global economy, including Brexit uncertainties
With rates close to the zero lower bound, Chair Yellen highlighted asymmetrical risks posed by the above uncertainties – if conditions surprise on the upside, the Fed would be able to use its conventional tools and raise rates, but downside surprise would see policy responses constrained by the zero lower bound:
Another factor that supports taking a cautious approach in raising the federal funds rate is that the federal funds rate is still near its effective lower bound. If inflation were to remain persistently low or the labor market were to weaken, the Committee would have only limited room to reduce the target range for the federal funds rate. However, if the economy were to overheat and inflation seemed likely to move significantly or persistently above 2 percent, the FOMC could readily increase the target range for the federal funds rate.
Humphrey Hawkins Q&A
Financial stability risk
Senator Shelby (Chairman, R-AL) raised the question of low rates and potential negative effects on financial stability by quoting a 2015 BIS report:
Our lens suggests that the very low interest rates that have prevailed for so long may not be “equilibrium” ones, which would be conducive to sustainable and balanced global expansion. Rather than just reflecting the current weakness, low rates may in part have contributed to it by fuelling costly financial booms and busts. The result is too much debt, too little growth and excessively low interest rates (Graph I.2). In short, low rates beget lower rates.
Chair Yellen responded that she does not see elevated financial stability risk nor “undue build-up of debt” in the economy. She acknowledged an increase in credit growth, but it is not “at worrisome levels.” She reiterated that the Fed will continue to monitor financial stability risk.
Senator Shelby inquired about the implication of Brexit on the U.S. economy, the common currency bloc, and the U.K.. Chair Yellen sees it “significant” for the U.K. and Europe as a whole, and it would usher in “a period of uncertainty” and negatively affect financial conditions and U.S. economic outlook.
Labor market conditions
Senator Brown (Ranking Member, D-OH) inquired on large number of job openings (“almost six million”), but April JOLTS had indicated softness in hire rate. He wanted to hear Federal Reserve’s plan to increase hiring. Yellen acknowledged “certain degree of mismatch” between worker skills and available job openings, and she recommended workforce development and job training programs to decrease mismatch (non-monetary policy solutions), in addition to fostering a strong labor market (monetary policy solution).
Senator Menendez (D-NJ) highlighted the decline in Federal Reserve’s Labor Market Conditions Index, that in the past the Fed had “moved to ease monetary policy, not tighten it” when the index had turned negative for five months or longer. Chair Yellen stressed that the published LMCI data refers to the change, not level, of the underlying index. In her view, the labor market is “operating at a good level,” but “without a doubt” there is “a loss of momentum.” Chair Yellen said the Fed expects this slowdown to turn around, but the Committee will take a cautious approach while “watching carefully” to validate that expectation.
Senator Scott (R-SC) highlighted a need for “dual-track” education apparatus to reduce skill mismatch, such as apprenticeship and skill training programs to increase STEM workers. Chair Yellen acknowledged the persistent trend of job polarization since mid 1980s, and it had resulted in rising inequality, high return to education, and downward wage pressure on less-skill workers. She agreed that education and training, such as apprenticeship used in some European countries, are ideas that have to be considered in addressing the hollowing out of middle-skill jobs.
Senator Toomey (R-PA) questioned on the correlation between Fed’s accommodative policies and malinvestments, that easy policy may have induced excess production of commodities (a reference to the debt-fueled U.S. shale revolution). Chair Yellen responded that investments had been running at a very slow pace (and investment growth had turned negative in recent months). The Fed Chair doesn’t see low rates resulting in an investment boom. Senator Toomey was not convinced, and he reiterated his view of distortions from low rates and its implications in overcapacity and overproduction in commodities.
Senator Warner (D-VA) expressed concerns over public companies’ increasing focus on short-term results (“95% corporate profits are now used for stock buybacks and dividends”) instead of long-term value creation (R&D, capital investment). He sees “increasing consensus” among CEOs and investors that this is “long-term destructive” to real value creation and ultimately job growth. Chair Yellen expressed sympathy and stated that the Fed has been trying to understand why investment spending has been at a “very depressed” level, and she identified the following catalysts:
- Economy has been growing slowly, and many firms do not need to invest much to meet demand
- Workforce has been expanding less quickly, and business do not need to increase spending to equip workers
Low rates on bank profitability
In response to a question from Senator Tester (D-MT), Chair Yellen acknowledged that a low interest rate environment has been “challenging” to banks and bank profitability.
Global bond yield correlation and yield differentials
Senator Heller (R-NV) highlighted that 10 year JGB and Bund yields had recently turned negative, and he questioned whether yield-seeking investors would increase demand for U.S. Treasuries. Chair Yellen concurred that this would tend to increase capital inflow to the U.S. and push down U.S. bond yields, and rising demand for the dollar would lead to currency appreciation and impact U.S. exports and economic conditions.
Senator Heller then asked Chair Yellen whether this means a Federal Reserve rate hike would still result in relatively low long-term Treasury yields (a reference to Greenspan’s Conundrum) and fail to tighten financial conditions, and Yellen responded that market responses will depend on expectations vs. realized Federal Reserve policy action and communication.
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