Yellen indicates continued stimulus trimming

Janet Yellen, fresh from taking the helm of the Federal Reserve, made it clear on Tuesday she would not make any abrupt changes to U.S. monetary policy, saying the central bank was on track to keep reducing its stimulus even though the labor market recovery was far from complete.

In her first public comments since becoming Fed chief earlier this month, Yellen said the central bank must keep its eye on the “unusually high” incidence of long-term unemployment and the “exceptionally high” proportion of Americans who can find only part-time work as it plots a tricky reversal of its very accommodative policy stance.

“By a number of measures our economy is not back, the labor market is not back, to normal,” she told the U.S. House of Representatives’ Financial Services Committee.

Fielding sharp questions from some Republican lawmakers, Yellen emphasized continuity with the policy approach taken by her predecessor, Ben Bernanke.

Under Bernanke, the Fed bought trillions of dollars in bonds to drive borrowing costs lower and encourage investment, swelling its balance sheet to more than $4 trillion. In December, it announced it was starting to scale back its support in a nod to a drop in unemployment and stronger economic growth.

While the U.S. unemployment rate has fallen by 1.5 percentage points since the latest bond-buying program began in 2012, at 6.6 percent it remains “well above levels” the Fed sees as consistent with maximum sustainable employment, Yellen said.

In only her second week on the job after serving as the Fed’s vice chair, Yellen received several accolades from both Republican and Democratic lawmakers on being the first woman chair in the central bank’s 100-year history.

But she referred to notes and appeared uncomfortable at times in addressing pointed questions on regulation.

At one point Yellen said she would have to study the details on a ban on bank proprietary trading before advising on how lawmakers might want to adjust the controversial so-called Volcker Rule.

Yellen, who was appointed to lead the Fed by President Barack Obama, was cut off at times by committee Chairman Jeb Hensarling and other Republicans as she tried to patiently explain the Fed’s two-pronged approach to supporting the economic recovery: buying bonds and promising low interest rates for a while to come.

Long concerned with the pain the recession caused U.S. workers, Yellen is seen by many investors as more likely than Bernanke would have been to do more to stimulate the economy even if inflation could eventually ramp up as a result.

The Fed has trimmed its monthly asset purchases by $10 billion at each of its last two policy meetings; it now buys $65 billion in Treasuries and mortgage bonds per month and it expects to wind down the program by later this year.

Yellen said the Fed will “likely reduce the pace of asset purchases in further measured steps” if economic data broadly supports policymakers’ expectation of improved labor markets and a rise in inflation.

She said, however, the purchases are not on a pre-set course, repeating the Fed’s policy line. And she reinforced the central bank’s expectation that inflation, while low now, will rise back toward the Fed’s 2-percent goal. By the Fed’s preferred indicator, inflation is running at just 1.1 percent.

Fed policymakers, who next meet on March 18-19, would consider halting the reductions in the purchases if there were “a notable change in the outlook” for the economy, Yellen said.

Only a “significant deterioration” in the outlook for the job market, or very serious concerns that inflation is not moving higher over time, would prompt policymakers to consider increasing the pace of purchases, she added.

Yellen nodded to the recent volatility in global financial markets, but said at this stage it did “not pose a substantial risk to the U.S. economic outlook.”

Prices for U.S. government bonds slipped and the dollar rose as investors digested Yellen’s comments, while U.S. stocks traded higher.

“It’s very obvious she is working from the same playbook as Bernanke,” said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York. “The Fed will continue to cut its bond purchases by $10 billion at each policy meeting the rest of the year.”

Hensarling is a long-standing critic of the aggressive Fed stimulus, which he and many other Republicans argue has enabled a huge run-up in U.S. debt. In opening remarks, he asked whether the so-called quantitative easing program will become “QE infinity.”

Republicans also worry the Fed’s aggressive easing of monetary policy could lay the groundwork for a troubling bout of inflation and asset bubbles.

Yellen cited the “unusually large fraction” of jobless Americans who have been out of work for more than six months, and the “very high” number of part-time workers who would prefer full-time jobs in defending the Fed’s stimulus.

“These observations underscore the importance of considering more than the unemployment rate when evaluating the condition of the U.S. labor market,” she said.

The Fed has said it does not expect to raise interest rates from near-zero until well after the time the jobless rate drops below 6.5 percent, especially if inflation remains weak. But with the jobless rate on the cusp of breaching this threshold, policymakers are considering how best to adjust their guidance.

More than five years after the 2007-2009 recession ended, the Fed has embarked on perhaps its most difficult policy shift as it tries to back away from flooding the financial system with ultra-easy money while at the same time convince investors that interest rates will stay near zero well into next year.

A shaky run of data has raised questions over whether the economy can sustain the strength it showed in the second half of last year – gross domestic product grew at a 4.1 percent annual rate in the third quarter and at a 3.2 percent pace in the fourth quarter.

A sharp slowdown in jobs growth over the past two months had some investors wondering whether the Fed might put the wind-down of its bond-buying program on hold.

“We have to be very careful not to jump to conclusions in interpreting what those reports mean,” Yellen said. She said unusually cold winter weather may have impacted the data even as she expressed surprise at the slowdown.-Reuters