The chair of the Federal Reserve has dropped the broadest of hints that it has put future US interest rate increases on hold following the plunge in global stock markets since the start of the year.
In testimony before Congress, Janet Yellen admitted that the selloff in shares on Wall Street had affected the growth prospects for the world’s biggest economy and left investors in little doubt that the US central bank had no intention of following last December’s increase in the cost of borrowing with a second increase in March.
“Financial conditions in the US have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar,” she said.
The Fed chief added that if the turmoil continued it would act as a brake on the economy and affect the jobs’ market. Yellen cited the uncertain prospects for the Chinese economy, the possible impact of falling commodity prices on emerging-market economies and financial market volatility as potential risks to the US economy.
But Wall Street was unimpressed with Yellen’s refusal to rule out a return to modest increases in interest rates at some point in the future should the financial market turmoil blow over. The Dow Jones industrial average was virtually unchanged in early afternoon trading in New York.
Rob Carnell, economist at IHS, said the Fed chief had retained “an open mind on the need for further tightening, though with a heavy skew of risks to the downside”. He added that she was defensive about the small increase in interest rates announced just before Christmas that was now seen as one of the triggers for the market turbulence in January and February.
In her first major speech for two months, Yellen sought to tread a fine line, acknowledging the threat posed by the financial tremors while at the same time pointing out that the US had continued to recover from the deep recession of 2008-09.
The Fed chief said: “The economy is in many ways close to normal.” Specifically, Yellen pointed out that the unemployment rate had declined to below 5%, which many of her Fed colleagues consider to be full employment, and that inflation was likely to move up to 2%.
What was not normal, she said, awere the federal funds rates, which had to be held for seven years at “exceptionally low levels”.
Yellen added that oil prices, steady job creation and faster wage growth should support growth of incomes and consumer spending. “Against this backdrop, the committee expects that with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in coming years and that labor market indicators will continue to strengthen,” she said.
She also defend the December interest rate hike, saying that had the Fed delayed raising the rates for too long “it might have to tighten policy relatively abruptly in the future … Such an abrupt tightening could increase the risk of pushing the economy into recession,.”
Yellen stressed that the Fed’s monetary policy was “accommodative” and was “by no means on a preset course”. The Fed would continue to monitor global economic and financial developments, including Chinese growth, which could pose risk to US economic growth, she added.
“As expected, Yellen tried to strike a balance between expressing concern about ‘global economic and financial developments’ and not giving up on the base case scenario of ongoing improvement in the economy and gradual tightening over time,” said Jim O’Sullivan, chief US economist at High Frequency Economics.
“The end result was no clear new signal relative to the last FOMC [Federal Open Market Committee] statement, including no specific signal for March, although there is enough focus on downside risks now to make a tightening move again that soon seem quite unlikely.”
In the 53 days since investors last heard from Yellen, when she held a press conference after overseeing the first US interest rate rise in nearly a decade, markets have been roiled with volatility and increasing doubt about the health of the US and global economies.
In that time, the S&P 500 has lost nearly 11% of its value and the 10-year note’s yield has declined by half a percentage point.
In its late January policy statement, the Fed altered its language to acknowledge that global financial and economic developments had clouded the outlook. Top Fed officials – including the vice-chairman, Stanley Fischer, and the Federal Reserve Bank of New York president, William Dudley – have referred to those concerns in recent speeches and interviews.