Monetary Policy Testimony Preview

Yellen will testify before Congress next week. On Tuesday, she will testify before the Senate Committee on  Banking, Housing, and Urban Affairs, followed by his appearance before the House Committee on Financial  Services on Wednesday. Her prepared remarks and responses to questions will likely be consistent with her remarks in mid-January, which we saw as reinforcing our view that she saw three hikes in 2017 as likely appropriate. (Click here for our analysis.) Market attention is focused on whether her remarks will lean one way or another concerning a March hike. We expect she will say, if asked, that, “of course March is on  the table, but whether or not the FOMC hikes will depend on the incoming data.” We continue to see the odds of a March hike as one in three but will reassess if there is news in the testimonies. 

Her opening remarks will be consistent with the February 2017 FOMC statement. ∙ While that statement did not provide an explicit signal about the prospect of a March hike, the language on inflation tilted in a slightly more hawkish direction. 

∙ Otherwise, the forward guidance about future rate hikes that have been in the statement will remain in  place, for example: “The Committee expects that economic conditions will evolve in a manner that will  warrant only gradual increases in the federal funds rate.” 

∙ We will, however, watch for any change in risk assessment, as global risks seem to have become more elevated. Potential political developments in France and Italy have already left a mark on European markets, though they have had a little obvious impact on U.S. markets to date. 

∙ Any discussion of these developments could be the most market-sensitive aspect of her two appearances, especially if they lowered market expectations of a March hike. 

Major data developments since her January speech include the GDP release and the employment report. ∙ The advance estimate of Q4 GDP slightly underperformed our expectations at 1.9%. But the report also showed a solid domestic demand had been offset by a huge drag from net exports. (Click here for the  complete analysis.) 

∙ The January employment report showed a labor market that continues to improve but with very little upward pressure on wages. That favorable combination left intact our expectation of three 2017 hikes with no hike in March. (Click here for the complete analysis.) 

∙ Recently, Yellen has been much more explicit than usual about her own rate projections: “As of last  month, I and most of my colleagues…were expecting to increase our federal fund’s rate target a few  times a year until, by the end of 2019, it is close to our estimate of its longer-run neutral rate of 3  percent.” 

We will watch for any further discussion of the end of the reinvestment program in her opening statement,  but we do not expect further clarification about the timing. In any case, the balance sheet will likely be a  topic in the Q&A. 

∙ The Fed’s investments in Treasuries, agency debt, and agency MBS have always been a lightning rod  for criticism. 

∙ The Monetary Policy Report normally depicts the historical evolution of the Fed’s balance sheet, but not its projected course going forward.

∙ In recent months, FOMC policymakers have increased their discussion of the end of reinvestment and the faster pace of rate hikes itself draws the timing closer. 

∙ As a result, we moved up our expected timing to the end of the current reinvestment program from early 2019 to the middle of 2018. (Click here for the complete analysis.) 

∙ Yellen will likely repeat the guidance about “well underway” in her opening remarks may be pressed by the Committee by more guidance. She will not do so in a Q&A. 

Yellen will likely be vague and circumspect with respect to questions about prospective fiscal stimulus under the Trump Administration. 

∙ In her recent speeches, she has noted that the FOMC adjusts its policy in response to any shock  (including, of course, shifts in the fiscal policy) that affects employment and inflation relative to their mandate-consistent levels. 

∙ Other FOMC participants (name some names) have been more explicit that looser fiscal policy will be accompanied by tighter monetary policy. The members of the oversight committees, on both sides of the aisle, might want to press her on this issue. And their reaction to a direct or indirect inclination by  Yellen to tighten monetary policy in response to faster growth generated by stimulative fiscal policy would be most interesting. The Fed’s view that the growth potential of the US economy is about 1¾%  will not rest comfortably alongside Republican aspirations to lift growth into the neighborhood of 3 to 4  percent. 

∙ On that topic, she may be asked by the Republicans how monetary policymakers might take into account the effects on the aggregate supply of prospective fiscal initiatives. We would expect her to not rule out some possible positive effects but to emphasize the uncertainties and express prudent caution about expecting too much. 

FOMC minutes and FOMC participants’ speeches have made increasing references to the employment situations of minorities. At times, some FOMC participants seem to be taking broader responsibilities for social outcomes than the more narrow mandates of monetary policy. These considerations bear on the question of whether to actively promote a “hot” labor market. 

∙ Promoting a hot labor market is seen as especially benefiting workers with higher-than-average unemployment rates, specifically minorities, perhaps suggesting that running a hot labor market would be socially valuable. 

∙ But Yellen has sharply backed away from being seen as advocating such a strategy, at least in an aggressive manner. She said recently that “allowing the economy to run markedly and persistently ‘hot’  would be risky and unwise.” 

∙ Still, the question has been raised whether promoting employment options for minorities is something the FOMC should take into account in its monetary policy decisions, and, if so, how. A direct question on this issue, most likely from the Democratic side would be interesting and revealing. 

How Yellen responds to mounting political pressure on the Fed’s operational independence will also be a  key focus. 

∙ She has opposed proposals to diminish the Fed’s discretion in setting rates. These proposals include,  most notably, following a mechanical interest-rate policy rule or explaining the reasons for deviation from that rule. 

∙ She dedicated a significant portion of a recent speech to the shortcomings of following simple policy  rules: “simple policy rules can serve as useful benchmarks to help assess how monetary policy should  be adjusted over time,” while warning that their prescriptions “must be interpreted carefully.” (Click  here for the complete analysis.) We would expect to maintain this position. 

∙ To build stronger relationships with lawmakers, she has reportedly initiated more discussion with individual members of Congress. Even if those meetings have yielded some benefits, the tenor of closed-door meetings and those of a congressional appearance are quite often very different.

∙ It seems quite likely that Fed reform legislation will be proposed again this year. Yellen and the Fed might do well to identify provisions that they would not oppose (possibly, for example, moving to four testimonies a year and releasing transcripts with a lag of three years rather than five) and to flag provisions that could be modified to make them more acceptable. Such a strategy might be more successful than rejecting them all out of hand. 

∙ For example, this would be an opportune time for her to offer to provide Congress with the rate projections from rules that the staff provides participants in advance of each meeting and as well as discussion of policy decisions about these prescriptions, perhaps in the Monetary Policy Report and/or the SEP. 

∙ Another sticking point might the increased focus on diversity in Fed appointments. With the Atlanta Fed and Richmond Fed appointing new presidents soon, Democrats may press her on this point. Bottom line: There is always the prospect that there will be some news made during the testimonies, but we are not anticipating comments that would materially affect our assessment of the prospect for a March hike. We continue to see the odds as one in three and will reassess after her testimony. 

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