Yellen's message to Trump: Put the US on a sustainable path

Federal Reserve chair Janet Yellen, noting uncertainty in the US economic outlook, says the central bank still sees a “gradual” pace of rate increases despite unknown fiscal policy. Yellen’s remarks sent yields on long-term government bonds (^TNX) surging, reversing most of February’s downturn in the 10-year yield.

“It is too early to know what policy changes will be put in place or how their economic effects will unfold,” Yellen said. “While it is not my intention to opine on specific tax or spending proposals, I would point to the importance of improving the pace of longer-run economic growth and raising American living standards with policies aimed at improving productivity.”

“I would also hope that fiscal policy changes will be consistent with putting U.S. fiscal accounts on a sustainable trajectory,” she added.

Yellen’s comments on economic policy come as she begins two days of testimony on Capitol Hill, delivering prepared remarks and her semi-annual monetary policy report to the Senate Banking Committee today.

Her cautious, yet generally positive, tone follows a slew of improving data, including better-than-expected ISM manufacturing growth, strong consumer confidence reports and solid payroll gains. The unemployment rate has hovered around 5% for the past year—a level many economists consider to be near full employment. However, output growth slowed in the fourth quarter, with real GDP estimated to have increased only 1.9%.

“[W]aiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession,” Yellen said.As Yellen meets with members of Congress, she will likely face questions on her leadership, interest rates, banking regulation, the Fed’s balance sheet, the labor market and the impact of Trump’s fiscal policies.

After the election of Donald Trump, inflation expectations surged as investors priced in prospects of new tax cuts and fiscal spending. The personal consumption expenditures index, the Fed’s preferred measure of price inflation, increased 1.6% in December from the year before, as core inflation rose 1.7%.

Given rising inflation and an improving labor market, the Fed raised rates by 0.25% in December, the second such increase in a decade, as Fed officials projected three quarter-point rate hikes this year.Also on the agenda: the future of Dodd-Frank and banking regulations, given the early departure of Fed Governor Daniel Tarullo, a key official heading bank regulation efforts. Tarullo announced last week that he plans to step down this spring, potentially opening a path for Trump to reshape Wall Street regulations.

Yellen will deliver the same report and remarks to the House Financial Services Committee tomorrow, however it is expected to be punctuated with a more lively Q&A session.