State Street Global Advisors comments on Fed Chair Yellen’s testimony on Capitol Hill

Market participants had been looking to Fed Chair Yellen’s testimony on Capitol Hill for any clear indication that the Fed had increased confidence in the path of interest rate hikes and in announcing the timing to start the process of running down their $4.5 trn balance sheet.

While Yellen and others on the Fed had recently expressed the view that a number of the key drivers of lower inflation numbers were transitory, her testimony both before the House yesterday and the Senate today appeared more cautious on this front. She noted that there was considerable uncertainty about when, and by how much, inflation will respond to tightening resource utilisation. While the economy has made considerable progress and the Fed holds the view that gradual increases in the federal funds rate will be required over time, the neutral rate is now quite low so fed funds will not have to rise by that much further to get to a neutral setting. In addition, no clear indication was given on the commencement date for the run down in the balance sheet, other than that it’s something that they should begin to do this year and in her opinion “relatively soon”, but the pace will be gradual and predictable.

It looks like confidence on the recent weakness in inflation being transitory is waning somewhat. In this light the Fed will be watching the inflation outlook very carefully as they decide on their next policy moves. This puts great focus on the US CPI numbers out this Friday. While the Q&A is with the Senate committee is still ongoing, the near term market reaction has been positive as the Fed seems committed to a very gradual pace of policy removal.

Brendan Lardner – EMEA head of portfolio management in the active fixed income team – State Street Global Advisors