Federal Reserve Chair Janet Yellen spoke a few times over the past week and we think her views remain consistent with previous comments. She continues to paint an upbeat scenario for the economy, stating, “prospects are favorable for further improvement in the U.S. labor market and the economy more broadly”. Given this view, if economic data continues as she expects, we believe the Federal Reserve Open Markets Committee (FOMC) would likely increase short-term rates later this year.
Particular to the labor markets, she noted that basically all the metrics the Fed monitors are showing improvements. That said, she also mentioned that “some slack” remains in the form of low labor force participation and that there are only “tentative signs” that wages are increasing.
Overall though, citing better consumer spending, she expects Q2 economic growth to be “moderate” – an improvement from the transitory softness of Q1. Key to this view is her expectations that some headwinds, like the strength of the dollar (which constrains the ability to export) and the rapid decline in oil-related investment outlays, are fading. We think these factors should permit growth to accelerate and the unemployment rate to move lower.
On the international front, Yellen acknowledges potential downside risks from Greece and China, but balances them with her sense of upside risks as well.
While always viewed as a bit of an inflation dove, Yellen anticipates that the low inflation environment is fleeting. Inflation readings were depressed by both the plunge in oil prices and the weakening of prices of imported goods (caused by the stronger dollar), but prices of both oil and the U.S. dollar have stabilized. While acknowledging that trailing 12-month figures will remain low for some time, she observes that recent inflation data has firmed. She expects this trend to continue: “my colleagues and I continue to expect that as the effects of these transitory factors dissipate and as the labor market improves further, inflation will move gradually back toward our 2% objective over the medium term”.
Finally, she said that if her forecast remains intact, it would be appropriate for the FOMC to “raise the federal funds rate target”. That said, she indicated that the pace of any rate increases would be gradual, and that monetary policy would likely remain relatively accommodative for quite some time.
This scenario of course remains data dependent, but consistent with our views. We believe a reasonable Q2 real GDP figure, continued job creation, and positive core inflation data could be enough to trigger a rate rise in September. Given the protracted communication around this, we believe few investors would be surprised and markets are likely to take such news in stride.
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