While Janet Yellen’s timetable for higher interest rates sent markets reeling, investors may have missed an important caveat: it depends on rising inflation.
Treasury yields jumped March 19 after Yellen said in her first press conference as Federal Reserve chair that rates could rise “around six months” after asset purchases end, most likely in the fall. At the same time, she cautioned that a decision on interest rates “depends what conditions are like.”
“Markets are not focusing enough on the conditionality,” said Jonathan Wright, an economics professor at Johns Hopkins University in Baltimore who worked at the Fed’s division of monetary affairs from 2004 until 2008. “If inflation fails to move back up” as the Fed expects, “that’s a reason to expect a later liftoff.”
Yellen’s comments this week followed the release of policy makers’ projections for the benchmark interest rate. The forecasts showed officials predicting the rate, now close to zero, would rise to at least 1 percent at the end of 2015, higher than their December forecast.
Yields on two-year notes, the government securities most sensitive to changes in interest-rate expectations, began to rise after the Fed released its economic projections. They jumped further after Yellen began the press conference, reaching the highest level since September and capping the biggest one- day gain since 2011.
The two-year Treasury yield was little changed late yesterday at 0.42 percent, after rising as much as 10 basis points on March 19.
In her press conference, Yellen played down the importance of the forecasts and said the outlook for inflation would influence policy makers’ deliberations on interest rates.
“If we had a substantial shortfall in inflation, if inflation is persistently running below our 2 percent objective, that is a very good reason to hold the funds rate at its present range for longer,” Yellen said.
A measure of inflation watched by the Fed, the personal consumption expenditures index, rose 1.2 percent in January from a year earlier and hasn’t exceeded the Fed’s 2 percent goal since March 2012. Fed forecasts released after the meeting showed inflation of 1.5 percent to 1.6 percent at the end of this year and 1.5 percent to 2 percent at the end of 2015.