Federal Reserve Chairwoman Janet Yellen and her top deputy signaled the central bank is on course to raise short-term interest rates as soon as this month and will seek to pick up the pace as the year wears on.
Boosting the benchmark federal-funds rate at the Fed’s mid-March meeting would signal greater confidence in the global economic backdrop and give officials a chance to space out increases evenly over the course of the year, officials’ long-stated preference, rather than pack them in later in the year.
If inflation and employment data continue to meet the central bank’s expectations, “a further adjustment of the federal-funds rate would likely be appropriate” at this month’s gathering, Ms. Yellen said Friday in Chicago.
Fed officials don’t want to wait too long to move and risk letting the economy overheat, which could require them to raise rates more rapidly later, possibly causing a recession, Ms. Yellen said. She added that she didn’t see any evidence the bank was “behind the curve” or moving so slowly that it risked letting the economy overheat.
Fed officials in December nudged up the federal-funds rate by a quarter percentage point, to between 0.50% and 0.75%, and said they expected to raise rates this year by another 0.75 percentage point, likely in three quarter-point moves. Ms. Yellen on Friday described that projection as “consistent” with the bank’s expectation for a gradual pace of rate increases.
Since then, the economic outlook has unfolded largely in line with Fed expectations. “There is almost no economic indicator that has come in badly in the last three months,” Fed Vice Chairman Stanley Fischer said Friday at a conference in New York.
The Fed’s preferred inflation measure in January rose 1.9% from a year earlier, putting the gauge closer to the central bank’s long-run objective of 2% than at any time since 2012.
The U.S. labor market has notched steady gains. Employers added 227,000 jobs in January, and the unemployment rate stood at 4.8%.
Optimism about President Donald Trump’s plans to slash taxes and regulations has pushed stock markets to new records, even amid a drumbeat of commentary from Fed officials this week signaling a higher likelihood they might raise rates this month.
“If there has been a conscious effort” to boost expectations of a rate rise, “I’m about to join it,” Mr. Fischer said. “I think the advice that has been given by a large number of members of the Fed, of the FOMC, is correct, and I strongly support it.”
Financial conditions have also eased, providing an opportunity to tighten policy without jarring bond markets. Rising asset prices could unleash “a substantial wealth effect,” Mr. Fischer said. “We’ve seen a lot of substantial change in a relatively short time.”
Spreads on investment-grade and high-yield corporate bonds have narrowed to their lowest levels since 2014, according to Bloomberg Barclays.
U.S. stocks were little changed on Friday after setting new highs earlier this week. The 10-year Treasury yield climbed to 2.492%, up from 2.317% at the end of last week.
The Fed has for some time signaled the March meeting was a possible time to boost borrowing costs. But markets only appeared to have taken the message seriously in recent days. On Monday, federal-fund futures tracked by CME Group implied investors saw a roughly 35% chance of an interest-rate increase this month. That jumped to around 80% on Friday.
Interest-rate futures suggest markets now expect the Fed to raise rates 2 1/2 times this year, moving closer to the Fed’s projections of three increases.
In recent years, officials faced a recurring predicament where they signaled a desire to tighten policy only to hold off after watching the U.S. economy underperform and face threats from abroad.
At the start of last year, for example, officials projected the economy would strengthen enough to allow four quarter-point increases. The economy didn’t cooperate. Growth slowed in the first quarter amid market volatility in China. Then in June, the U.K. decision to leave the European Union fueled market volatility and again sapped the urgency for rate increases. The central bank ultimately raised rates just once last year, in December, after raising them just once in 2015.
This year so far has been different because the economic outlook hasn’t dimmed. The economy has “essentially met” the Fed’s mandate to achieve full employment “and inflation is moving closer to our 2% objective,” Ms. Yellen said Friday. As a result, the process of raising rates “likely will not be as slow as it was during the past couple of years,” she said.
More than one quarter-point rate increase this year would push the federal-funds rate over 1% and give the central bank more room to cut rates if it wants to provide more economic support in a downturn.
Spacing out rate increases could also tamp down the urgency to address the Fed’s $4.5 trillion holdings of bonds and other assets, or its balance sheet. While the meeting this month is likely to include discussions on how to manage the balance sheet, top officials have signaled they are nowhere near ready to begin winding it down.
Ms. Yellen told lawmakers last month the Fed would hold the balance sheet steady until it is confident that “the economy is on a solid course and the federal-funds rate has reached levels where we have some ability to address weakness by cutting it.”
She and other top officials have also doused the idea, floated recently by regional bank presidents, that shrinking the balance sheet could be used as a complementary tool for tightening monetary policy. The federal-funds rate “is our traditional tool,” she told lawmakers. “It’s the one that we have the most confidence in.”
The March meeting arrives at a delicate moment for the Fed. Officials see the economy nearing full employment, and they want to proceed with steps to prevent any overheating. At the same time, the Trump administration wants to rev up growth, in part to draw millions of idled workers off the sidelines and into the labor force.
During the presidential campaign last year, Mr. Trump repeatedly criticized Ms. Yellen and accused the Fed of keeping rates low to help then President Barack Obama. Fed officials have said the central bank doesn’t take politics into account when setting policy.
Mr. Trump hasn’t publicly discussed the Fed since his election victory, though he has an early opportunity to put his stamp on the institution. Two seats on the board of governors are vacant and a third official, Fed governor Daniel Tarullo, has announced his intent to step down next month. Ms. Yellen’s term as chair expires in 11 months, though her term as governor isn’t up until 2024.
Many economists expect fiscal policy to provide some boost to the economy in the next year, but the size and timing of any package is highly uncertain. On fiscal policy, “I think most of my colleagues and I have decided that we should simply be patient and wait to see what happens, and alter our economic forecasts and views on appropriate policy until we have a clearer understanding,” Ms. Yellen said Friday.
March could be an attractive time to raise rates because it is “sufficiently ahead of possible fiscal legislation or the end of Yellen’s term that the Fed should successfully avoid accusations of ‘playing politics,’” said economists at Credit Suisse in a research note this week.
Article written by Nick Timiraos and Harriet Torry via WSJ