Yellen: Case for rate hike 'has strengthened'

Federal Reserve Chair Janet Yellen  on Friday told the world what it already knew: An interest rate hike will happen. When exactly that move is coming remains uncertain.

At the Fed’s annual symposium in Jackson Hole, Wyo., Yellen said the case for a rate hike “has strengthened in recent months” in light of recent strong job growth, but she gave no signal that Fed policymakers will make a move at a meeting next month.

Yellen said the Fed’s policymaking committee “continues to anticipate that gradual increases in the federal funds rate will be appropriate over time” to meet the Fed’s goals for inflation and employment.

The markets were satisfied by the lack of surprises in Yellen's remarks, said Tim Drilling, regional investment director of U.S. Bank's Private Client Reserve. "It was completely in line with most expectations," Drilling said in an interview. "The takeaway is nothing's changed."

Meanwhile, Fed Vice Chairman Stanley Fischer said on CNBC that next Friday's report on August job gains could factor into the Fed's decision at its September 20-21 meeting, a remark that appeared to keep a rate increase on the table.

The Dow Jones industrial average initially rose after Yellen spoke, but logged a small decline later as the market digested the remarks from Fischer. The index finally closed down 53 points for the day at 18,395.

The 10-year Treasury yield was unchanged at 1.62%.

The Fed raised its benchmark interest rate in December for the first time in nine years but has stood pat since then, leaving it at a historically low 0.4%.

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In earlier statements, Yellen had said a rate increase would be likely “in coming months” but that timetable has been removed from recent Fed communications. Although job growth bounced back strongly in June and July, averaging 273,000 a month, after a spring slump, economic growth has been weak for three straight quarters, inflation remains stubbornly below the Fed’s annual 2% target, and the United Kingdom’s Brexit vote amplified concerns about a weak global economy.

Still, Yellen added, “I believe the case for an increase in the federal funds rate has strengthened in recent months.” The remark appears to at least leave the door open to a September rate increase if next week’s employment report shows strong payroll gains again in August. Markets, however, say the odds are low that the Fed will act next month, and many economists say a move is more likely after the presidential election in November removes a cloud of political uncertainty.

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Yellen devoted most of her speech to the broader concern of how the Fed could respond to another recession with limited ability to cut a benchmark interest rate that is still just slightly above zero and is expected to remain at about 3% longer term in light of persistent headwinds to growth. Those include weak productivity gains in advanced economies, slower growth in working age populations and sluggish business capital spending.

Yellen noted that a recent research paper concluded that bond purchases similar to those the Fed made in the years following the 2008 financial crisis -- combined with cutting the key rate to near zero and assurances the Fed will keep the low -- would be adequate to respond to a downturn. In fact, the paper said such an approach would be at least as effective as cutting the federal funds rate below zero – a step that central banks abroad have taken but the Fed is hesitant to make because it could disrupt money market funds.

The Fed’s more than $3 trillion in purchases of Treasury bonds and mortgage-backed securities lowered long-term interest rates, keeping mortgage rates, corporate bonds and other borrowing costs low for consumers and businesses, stimulating economic growth.

Yellen, however, noted that this analysis may be too optimistic, in part because long-term rates are already likely to be unusually low. Also, she said, the Fed may have even less room to cut its benchmark rate because slow growth may keep it only 2% long-term. Also, she said, assurances that the Fed will keep the rate low "might inadvertently encourage excessive risk-taking and so undermine financial stability.".

As a result, she said, the Fed may need to take other steps to respond to a downturn, such as raising the Fed’s inflation target above 2%,  allowing the economy to overheat for a period.  Another option would be for the Fed to target price levels or growth in gross domestic product as it adjusts interest rates, rather than simply its current targets of inflation and unemployment, she said.

“I should stress, however, that the (Fed) is not actively considering these additional tools and policy frameworks, although they are important subjects for research,” she said.

Contributing: Nathan Bomey