Janet Yellen, chair of the Federal Reserve, is delivering more good news to the financial markets in her Semiannual Monetary Policy Report to the Congress before the Senate’s Committee on Banking, Housing and Urban Affairs. The report will be full of good news for those who feared a rising rate environment that would be faster and more sharp than many would have hoped for. Still, the door for rate hikes has been left open — if the global situation allows it.

Yellen addressed the employment situation in the United States as “improving along many dimensions” with the unemployment rate now at 5.7%. This is down from 6.0% last summer and down from right at 10% at its peak in late 2009. Yellen also indicated that domestic spending and production “have been increasing at a solid rate” now that real gross domestic product (GDP) is estimated to have increased at 3.75% annually during the second half of last year.

Then comes the discussion about interest rates. Yellen said:

Despite the overall improvement in the U.S. economy and the U.S. economic outlook, longer-term interest rates in the United States and other advanced economies have moved down significantly since the middle of last year; the declines have reflected, at least in part, disappointing foreign growth and changes in monetary policy abroad.

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Yellen further discussed price trends, saying another notable development has been the plunge in oil prices — due to increased global supply rather than weaker global demand. Yellen discussed the mixed impact being a net-net positive:

While the drop in oil prices will have negative effects on energy producers and will probably result in job losses in this sector, causing hardship for affected workers and their families, it will likely be a significant overall plus, on net, for our economy. Primarily, that boost will arise from U.S. households having the wherewithal to increase their spending on other goods and services as they spend less on gasoline.

With the exception of the paragraph on the employment situation, Janet Yellen’s longest paragraph in her introductory comments discussed international market woes. Is this to mean that global policy is now a third Fed mandate after full employment and stable prices? Yellen said:

Foreign economic developments, however, could pose risks to the outlook for U.S. economic growth. Although the pace of growth abroad appears to have stepped up slightly in the second half of last year, foreign economies are confronting a number of challenges that could restrain economic activity. In China, economic growth could slow more than anticipated as policymakers address financial vulnerabilities and manage the desired transition to less reliance on exports and investment as sources of growth. In the euro area, recovery remains slow, and inflation has fallen to very low levels; although highly accommodative monetary policy should help boost economic growth and inflation there, downside risks to economic activity in the region remain. The uncertainty surrounding the foreign outlook, however, does not exclusively reflect downside risks. We could see economic activity respond to the policy stimulus now being provided by foreign central banks more strongly than we currently anticipate, and the recent decline in world oil prices could boost overall global economic growth more than we expect.

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On rates, Yellen confirmed that U.S. inflation continues to be running lower than the 2% objective of the Federal Open Market Committee (FOMC). The drop in oil prices was listed as a key driver, but the consumer price component also reflects declines in the prices of many imported items. Yellen further said:

Despite the very low recent readings on actual inflation, inflation expectations as measured in a range of surveys of households and professional forecasters have thus far remained stable. However, inflation compensation, as calculated from the yields of real and nominal Treasury securities, has declined. As best we can tell, the fall in inflation compensation mainly reflects factors other than a reduction in longer-term inflation expectations. The Committee expects inflation to decline further in the near term before rising gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of lower energy prices and other factors dissipate, but we will continue to monitor inflation developments closely.

Selected additional commentary includes our summary to outline each point made. Yellen’s discussion on the rate hike timing and outlook and aspects of the decision making is as follows:

• Long-Term Accommodation: “The Committee judges that a high degree of policy accommodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term.”
• Patience Grasshopper: “The Committee judged, in December and January, that it can be patient in beginning to raise the Federal Funds rate. The FOMC’s assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings.”
• Sooner, or Later?: “If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance.”
• Contingent Modifications: “It is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee’s judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting.”
• Labor Target First, Inflation Second: “Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.”
• Low Rates to Remain: “It continues to be the FOMC’s assessment that even after employment and inflation are near levels consistent with our dual mandate, economic conditions may, for some time, warrant keeping the federal funds rate below levels the Committee views as normal in the longer run. It is possible, for example, that it may be necessary for the federal funds rate to run temporarily below its normal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity.”
• What is Normal Fed Funds?: “As such factors continue to dissipate, we would expect the federal funds rate to move toward its longer-run normal level. In response to unforeseen developments, the Committee will adjust the target range for the federal funds rate to best promote the achievement of maximum employment and 2 percent inflation.”
• Mandate (Without International Markets): “Last September, the FOMC issued its statement on Policy Normalization Principles and Plans. This statement provides information about the Committee’s likely approach to raising short-term interest rates and reducing the Federal Reserve’s securities holdings… The Committee will determine the timing and pace of policy normalization so as to promote its statutory mandate to foster maximum employment and price stability.”
• FOMC Normalization: “The FOMC intends to adjust the stance of monetary policy during normalization primarily by changing its target range for the federal funds rate and not by actively managing the Federal Reserve’s balance sheet.”
• Raising Rates: “The Committee is confident that it has the tools it needs to raise short-term interest rates when it becomes appropriate to do so and to maintain reasonable control of the level of short-term interest rates as policy continues to firm thereafter, even though the level of reserves held by depository institutions is likely to diminish only gradually.”
• How High on Rates: “The primary means of raising the federal funds rate will be to increase the rate of interest paid on excess reserves. The Committee also will use an overnight reverse repurchase agreement facility and other supplementary tools as needed to help control the federal funds rate. As economic and financial conditions evolve, the Committee will phase out these supplementary tools when they are no longer needed.”
• Balance Sheet: “The Committee intends to reduce its securities holdings in a gradual and predictable manner primarily by ceasing to reinvest repayments of principal from securities held by the Federal Reserve. It is the Committee’s intention to hold, in the longer run, no more securities than necessary for the efficient and effective implementation of monetary policy, and that these securities be primarily Treasury securities.”

What’s important is that Janet Yellen has signaled that investors, economists, businesses and consumers need not fear a rapidly rising interest rate environment any time soon. Sure, there are outs and contingencies if the global market improves. Still, the dual mandate of full employment and stable inflation around 2% now seem to have migrated to a tri-mandate that includes international economic and currency stability.

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