Yellen sticks to the script

In her semi-annual monetary policy testimony to the Senate Banking Committee today, Fed Chair Janet Yellen stuck to her existing message, stressing that even though “measures of labour utilization have… registered notable improvements over the past year”, “significant slack remains in labour markets.” As a result, Yellen appears in no rush to begin normalising interest rates, even though the pace of employment growth has accelerated and the unemployment rate has fallen to 6.1%. We’re not so sure. Survey measures showing that jobs are increasingly hard to fill, which indicates to us that the decline in the unemployment rate does reflect a genuine dwindling of the spare capacity in the labour market.

Yellen didn’t entirely dismiss the recent rise in inflation, as she tried to in her last post-FOMC press conference, which is encouraging. She again noted that, up to now at least, wage growth has remained muted. That is true, but where our view differs from the Fed is that we expect both wage and price inflation to accelerate in the second half of the year, which we anticipate will eventually prompt the Fed to begin raising rates in March next year. That’s a little earlier than markets appear to be pricing in.  Yellen did acknowledge in her testimony that depending on how economic conditions evolve, rates could start to rise sooner or later than the Fed’s forecasts currently suggest.

Overall, after beginning to raise the fed funds rate in March next year, we anticipate the Fed will hike its policy rate to 1.25% by end-2015 and 3.0% by end-2016.