Federal Reserve Sees Strong Economy, No Rate Hike Yet

The economy continues to grow and the job market has gotten close to the Fed’s goal of maximum employment, according to Fed Chairwoman Janet Yellen.

The economy continues to grow and the job market has gotten close to the Fed’s goal of maximum employment, according to Fed Chairwoman Janet Yellen.

Yellen said drags on inflation from commodities and the strong U.S. dollar will likely diminish next year. In her testimony to Congress, Yellen said the “U.S. economy has recovered substantially” since 2009, with unemployment falling to 5 percent, noting that this represents a “normal level” of unemployment in the eyes of the FOMC. Although she did not mention the declining labor participation rate, which has fallen to its lowest point since the 1970s, she did add that 271,000 new jobs in October, indicating “continued improvement” in the labor markets.

Yellen also noted that real GDP growth has “increased at a moderate past on balance,” revealing that it rose 2.25 percent in the first three quarters of 2015, with growth expected to increase at about that same rate for the rest of the year. Net exports were a negative drag on real GDP growth, Yellen pointed to slow foreign growth and the appreciation of the U.S. dollar as the culprits.

However, Yellen noted that domestic activity, which contributes 85 percent of economic activity in the United States, remains strengthened by car sales, job growth, and more discretionary purchasing power for Americans. Rising home values, debt reductions, and rising stock values have also risen Americans’ net worth, again allowing for more consumption throughout the market. Yellen said this could cause greater spending on durable goods in the future, again bolstering economic growth.

Looking forward, Yellen sees continued economic growth, higher inflation, and improved employment, with risks to these catalysts “very close to balanced.”

Oil a Non-Issue

Yellen dismissed the weakness in oil and commodities sectors and dismissed the weak inflation measured by the personal consumption expenditure index, which has risen barely above 1% in 2015. She also acknowledged that core PCE is up just 1.25%, undermining her insistence that oil and commodities are dragging inflation lower.

Monetary Policy

On the Fed’s monetary policy, Yellen reaffirmed that the FOMC will increase rates when it believes inflation is close to reaching its 2 percent target. “I currently judge current U.S. economic growth will be sufficient,” Yellen said, adding that “long term inflationary expectations remain reasonably well-anchored” which gives her confidence that 2 percent inflation will come to America relatively soon.

“It’s appropriate to be more cautious in raising” the Federal funds rate, Yellen noted, as she believes the Fed is currently in a position to prepare for downside shocks to growth, while “abrupt tightening would disrupt financial markets” and possibly drive the U.S. into a recession.

“On balance, financial and economic information received since October has been consistent with our expectation of continued improvement in the labor market,” she said, adding that inflation will rise to its 2% target “in the medium term.”