Fed Chair Janet Yellen testifies on Tuesday and Wednesday this week to House and Senate Committees as part of the Fed’s mid-year report on monetary policy. Last week’s release of the FOMC minutes from the June 17-18 meeting set the stage for this week’s testimony and questions. The big question — when will the Fed begin raising interest rates – won’t get an answer from Mrs. Yellen. The consensus guess is mid-2015; since the release of the minutes and the May employment report many analysts have moved their dates closer to now.
Other questions were answered and will probably be debated. While the current round of quantitative easing and bond buying will end in October, the Fed will continue to reinvest funds from coupon interest and maturing bonds until sometime after they begin raising interest rates. Yes, the Fed noted the recent uptick in some inflation measures which occasioned a lot of discussion among bloggers, and no, it is not worried about inflation and won’t respond with higher interest rates out of fears of inflation.
After some ups and down last week, the stock market will be listening with care. Given the FOMC minutes and the recent tone of Fed comments, the testimony shouldn’t send stocks into a tailspin. Comments on the economy will be neutral at best and won’t encourage any buying or upward revisions of earnings estimates. Old-line monetarists who worry a lot about inflation may be even more worried given Janet Yellen’s earlier comments on inflation. The wild card in the Q&A sessions in both the House and the Senate could be comments by a minority who want to hobble the Fed by forcing it to follow arbitrary policy rules or build a wall between interest rate policy and all bank regulation. Some in Congress are jealous of the Fed’s policy-making power or don’t wish to recognize the crucial and successful role it played during the financial crisis. Remarks about the Fed’s structure will only heighten uncertainty about future monetary policy.
Most of the questions from representatives and senators are likely to focus on the economy and recovery, but a few may get wonkish and discuss how, not when, the Fed will raise interest rates. One of the long running complaints about quantitative easing is that it flooded the banking system with excess reserves. Initially some feared that all that money would create inflation; it hasn’t. Now the question will be how to raise interest rates when it is impossible to drain enough excess reserves to create upward pressure on the fed funds rate. The FOMC minutes covered this issue., The Fed will continue to pay interest on excess reserves (IOER) and this rate will be a key policy tool going forward, Second, the Fed will establish an overnight reverse repurchase facility to supplement the IOER and drain reserves for brief time periods.
The FOMC did note one challenge it will face, both with Congress and the markets. With new policy tools, it will need to explain and educate both sets of constituents about what it is doing and how things will work. This week’s testimony may be an early signal of this education effort.
Stay tuned this week for the testimony and what it all means.
This article was written by David Blitzer, chairman of the index committee, S&P Dow Jones Indices.
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