Fed’s most powerful trio keeps December rate rise on table

Federal Reserve Chairwoman Janet Yellen and New York Fed President William Dudley both said the central bank could boost interest rates as soon as next month, while Fed Vice Chairman Stanley Fischer voiced confidence that inflation isn’t too far below the central bank’s goal.

“At this point, I see the U.S. economy as performing well,” Yellen said on Wednesday in testimony before the House Financial Services Committee in Washington, D.C. If economic data continue to point to growth and firmer prices, a December rate hike would be a “live possibility,” she said.

Speaking in New York hours later, Dudley said he agreed with the chair, but “let’s see what the data shows.” Fischer didn’t comment on the timing of liftoff during a speech Wednesday evening in Washington, but said that price pressures will move toward the Fed’s target.

The Federal Open Market Committee said in its October statement that it will consider raising rates at its “next meeting,” citing “solid” rates of household spending and business investment. The comments from Yellen, Dudley and Fischer, who are considered the three most influential members of the committee, reinforced the idea that next month is in the crosshairs for an increase if economic progress holds up.

“There are pretty good odds that the Fed will hike rates in December as long as employment perks back up and the unemployment rate slips further, which is what we are looking for,” Mark Vitner, a senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina, said after Yellen’s remarks. “She is trying to keep the Fed’s options open in December.”

Still undecided

No decision has yet been made on the timing of a rate increase, Yellen cautioned. The Fed chair appeared before the committee to testify primarily on the Fed’s supervision and regulation of financial institutions.

“What the committee has been expecting is that the economy will continue to grow at a pace that’s sufficient to generate further improvements to the labor market and to return inflation to our 2 percent target over the medium term,” she said.

Markets interpreted Yellen’s remarks as a sign that a rate hike in December is more likely. Investors have raised to almost 60 percent the probability of a rate increase by policy makers’ December meeting, according to pricing in the federal funds futures market. That compares to 33 percent a month ago, assuming the effective funds rate average is 0.375 percent after liftoff.

U.S. central bankers have held the policy rate near zero since 2008 as they have waited for labor markets to move closer to their goal of full employment.

The unemployment rate stood at 5.1 percent in September, slightly above the 4.9 percent rate that officials estimate would satisfy their mandate. The Bureau of Labor Statistics will release the October jobs data Friday.

Job market

“I see under-utilization of labor resources as having diminished significantly since earlier in the year, although recently we’ve seen some slowdown in the pace of job gains,” Yellen said.

The Fed has missed its 2 percent inflation target for more than three years, and its Oct. 28 statement said they need to be “reasonably confident” that prices will rise toward their goal before raising rates.

“If we were to move, say in December, it would be based on an expectation, which I believe is justified, that—with an improving labor market and transitory factors fading—that inflation will move up to 2 percent,” Yellen said.

Fischer went a step further in remarks later on Wednesday in Washington, saying that the Fed isn’t that far off the mark, even now.

"We’re not that far from the 2 percent target,” Fischer said, pointing to core inflation and explaining that he believes factors holding prices back—the plunge in oil and a rising dollar—should prove transitory. "Those are things that can’t go on forever."

Michael Gapen, chief U.S. economist at Barclays Capital Inc. in New York, said Yellen’s comments on inflation served to deflect an argument outlined in October by Fed Governor Lael Brainard that the central bank should wait to see movements in inflation before raising rates.

Outlook dependent

Yellen rejected that argument in favor of a “forecast-based decision,” Gapen said.

“The divide in the committee was essentially over whether they should move in advance of inflationary pressure or wait to see it,” he said. “This clearly says the forecast-based side won that argument.”

Fischer sided with Yellen, saying he believed the relationship between unemployment and inflation, which holds that lower joblessness will eventually boost wages and spur bigger increases in prices, will reassert itself.

The so-called Phillips Curve relationship will “be back,” he said.

Answering questions from reporters, Dudley said the decline in inflation expectations recorded in the New York Fed’s consumer survey is a little concerning, and is corroborated by a University of Michigan survey which shows a similar trend. While he described expectations as still well-anchored, he acknowledged that they were near the bottom of recent ranges, and a further decline would raise the level of concern.

While Gapen said a December hike is now the Fed’s “base case,” Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York, disagreed.

More improvement

“The economy has to show further improvement for Yellen to actually steer the committee to December liftoff,” Rupkey said. “They have put the market on notice, but now the economic data has to cooperate or they may very well delay the 2015 liftoff into early next year.”

Economic growth slowed to a 1.5 percent annualized pace in the third quarter, according to the government’s advance estimate on gross domestic product. However, inexpensive gasoline prices, low unemployment and income gains are projected to sustain spending.

The pace of growth will quicken to a 2.7 percent rate in the final three months of the year, according to economists surveyed by Bloomberg.

Fed officials’ last meeting of the year will be held Dec. 15-16, and it includes a press conference with Yellen and a new set of forecasts from policy makers.

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