When the Federal Reserve announced last week that Fed Chair Janet Yellen had scheduled a speech for March 3, which happened to be the last day before the Fed’s self-imposed “blackout” period before its March 15 Federal Open Markets Committee (FOMC) meeting, it did not take much imagination to conclude that she had an important message to relay.
Yellen did not disappoint, offering what in the context of “Fedspeak” constituted unusually clear guidance that a rate hike is probable later this month. In fact, Yellen had declared in mid-February, during her semi-annual congressional testimony on monetary policy, that as long as the economy evolved in line with the Fed’s expectations, “a further adjustment of the federal funds rate would likely be appropriate…at our upcoming meetings.”
{mosads}The financial markets took note, but there was such an overwhelming consensus that the Fed would not raise rates so soon after its December increase that her message was largely ignored. Since then, a host of Federal Reserve officials have come out publicly in favor of a near-term rate hike. In some cases, officials have explicitly argued for a March move.
Finally, this week, under the weight of what had become an overwhelming coordinated messaging campaign from the Fed, markets begrudgingly came to the conclusion that the FOMC does, in fact, intend to move interest rates higher when it meets later this month.
Chair Yellen’s speech today provided the final nail in the coffin, as she tweaked her February comments to provide even clearer guidance with respect to March. She noted that, “we currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect.
“Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate,” Yellen said.
Note that her language shifted from “at our upcoming meetings” back in February to a specific reference to the March FOMC meeting today. Moreover, the number of key data releases still to be seen before March 15 is down to one — the February employment report — so the economy does not have much “evolving” left to do! Rarely has a Fed chair been this explicit in tipping the Fed’s hand in such a public way.
The broader context of Chair Yellen’s speech was also quite interesting. The bulk of her speech explained and defended the Fed’s ultra-cautious strategy over the last three years, when, despite considerable improvement in the economy, the Fed only managed to raise rates twice.
The Fed left the federal funds rate near zero while not touching the bloated balance sheet that ballooned due to multiple rounds of quantitative easing early this decade. While I quite firmly disagree with her defense of the Fed’s foot-dragging over the past two years, I found the way that she structured her story to be very interesting.
To get from the 2014-2016 narrative to where we are now, when the Fed is preparing to raise rates for the second time in three months, something must have changed. It is the evolution in the way that the Fed sees economic conditions that explains the shift in officials’ stance.
Yellen pointed to two main reasons that the Fed is becoming increasingly willing to move rates back toward normal after years delay. First, downside “risks emanating from abroad appear to have receded somewhat,” she said.
At various points over the past two years, fears regarding an economic blow-up in China, deflation in Europe, and turbulence following the Brexit vote, have forestalled the Fed’s normalization efforts. Now, those issues are not much of a concern.
Second, inflation has moved higher, bringing it closer to the Fed’s 2 percent target. For most of 2015 and 2016, temporary declines in energy and import prices had dragged down aggregate inflation gauges. As those effects have worn off, inflation has risen and is currently quite close to target.
I would add a third unspoken development. Since the election, the prospect of a more growth-friendly fiscal and regulatory policy has buoyed consumer and business confidence and driven a surge in equity prices.
While actual economic growth has not picked up yet and most Fed officials are waiting for more details of tax plans before bumping up their official growth forecasts, it is clear that the prospect of fiscal and regulatory policy changes presents additional upside possibility for the economy, further diminishing the justification for a super-easy monetary policy stance.
Thus, Chair Yellen’s speech today tells us that, not only is the Fed likely to raise rates in March, but it’s also serious about raising rates more than once or twice in 2017. That scenario would differ dramatically from both 2015 and 2016, when the Fed projected multiple rate hikes but delivered only one each year.
Stephen Stanley is the chief economist for Amherst Pierpont Securities. He is a frequent guest on CNBC and Bloomberg TV programming.
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