The US economy is currently not in its best shape. However, Yellen provided a rather optimistic view of its state, while the standoff within the Republican Party over tax cuts and next year’s budget hardly added certainty regarding the direction of broader US economic policy.
Yellen said before the Congress on Wednesday that the central bank is lacking certainty of whether the US inflation, one of the key macroeconomic indicators, is going to reach the Fed target of 2 percent. Currently at 1.6 percent last month, US inflation eased from its previous reading of 1.7 percent year-on-year, rendering thwe Fed tightening cycle increasingly unsustainable and stirring concern of an economic slowdown.
“There was uncertainty about when and how much inflation will respond to tightening resource utilization,” Yellen said in her Congress testimony.
The Federal Reserve, meanwhile, released one of its key macroeconomic surveys, known as the Beige Book, in which central bank analysts observed that US worker compensation and gains in consumer prices remain tepid despite the ‘full employment’ situation in the labour market. The data added uncertainty to investor perception of the US economy, and contrasted Yellen’s overall optimistic assessment of the state of affairs in the world’s largest economy.
“The majority of districts (governed by regional Federal Reserve banks) expected modest to moderate gains” in the pace of GDP expansion in the near-term, the Beige Book, released on Wednesday, read. Gains in job creation, however, remains “modest to moderate”, the Fed analysts said, while inflation “continued to rise modestly in the majority of districts.”
“If US prices continue to decline, it’ll be hard for the markets to sustain the current mood toward monetary tightening, and some markets are already starting to feel that now,” Daisuke Karakama of Tokyo-based Mizuho Bank Ltd. said.
The Federal Reserve have hiked base borrowing costs four times starting in December 2015, and are on course to undertake another hike till the yearend, as well as commence decreasing their bloated balance sheet. These measures are seen as a preparation for the White House’s fiscal stimulus package, which is poised to become the main driver of the US economic expansion in the coming decade, according to President Donald Trump’s plan.
US central bank, Yellen said, is closely “monitoring” the inflation developments, and expressed her confidence that the economy will continue to grow in the coming years, ruling out any speculation of a looming recession. The Fed will therefore keep raising interest rates to bring monetary conditions in line with normality at above 5 percent, as well as cutting the $4.5-trillion balance sheet.
Goldman Sachs analysts said in a note released after Yellen’s testimony on Wednesday that they expect the central bank to undertake another interest rate hike in December, as the Fed are likely to take a break and watch whether inflation and broader economic growth will rebound in line with labour market developments. An interest rate hike in September in unlikely, Goldman observed – another factor behind the dollar’s weakening.
Typically, a national currency faces higher demand ahead of monetary tightening steps, and anticipated Fed delays are not encouraging a higher demand for the dollar.
Historically, the Federal Reserve would undertake rate hikes once a quarter, but the current tightening cycle is characterised by a very gradual pace of policy adjustment, with wide gaps between hikes, between six and twelve months. Such a situation also does not contribute to a precise policy transmission to the economy, meaning the central bank’s grip on the situation is weaker than it used to be in the past decades.