On Friday, Federal Reserve Chair Janet Yellen spoke on "From Adding Accommodation to Scaling It Back," indicated that the Fed was likely to hike short-term interest rates at its meeting next week (March 14-15). Money fund yields, which were relatively flat in February after rising in December and January, should again move higher immediately following the Fed move. We review Yellen's speech and The Wall Street Journal article, "Yellen Signals Rate Increase Likely at March Fed Meeting," on the pending hike, and we also briefly discuss the likely impact on money market fund yields, below.
Yellen explains in her speech, "The slower-than-anticipated increase in our federal funds rate target in 2015 and 2016 reflected more than just the inflation, job market, and foreign developments I mentioned. During that period, the FOMC and most private forecasters generally lowered their assessments of the longer-run neutral level of the real federal funds rate.... In response to this growing evidence, the median assessment by FOMC participants of the longer-run level of the real federal funds rate fell from 1-3/4 percent in June 2014 to 1-1/2 percent in December 2015 and then to 1 percent in December 2016."
She continues, "The U.S. economy has exhibited remarkable resilience in the face of adverse shocks in recent years, and economic developments since mid-2016 have reinforced the Committee's confidence that the economy is on track to achieve our statutory goals.... On the whole, the prospects for further moderate economic growth look encouraging, particularly as risks emanating from abroad appear to have receded somewhat. The Committee currently assesses that the risks to the outlook are roughly balanced. Moreover, after remaining disappointingly low through mid-2016, inflation moved up during the second half of 2016."
The Fed Chair says, "With the job market strengthening and inflation rising toward our target, the median assessment of FOMC participants as of last December was that a cumulative 3/4 percentage point increase in the target range for the federal funds rate would likely be appropriate over the course of this year. In light of current economic conditions, such an increase would be consistent with the Committee's expectation that it will raise the target range for the federal funds rate at a gradual pace and would bring the real federal funds rate close to some estimates of its current neutral level. However, partly because my colleagues and I expect the neutral real federal funds rate to rise somewhat over the longer run, we projected additional gradual rate hikes in 2018 and 2019."
She also comments, "Our individual projections for the appropriate path for the federal funds rate reflect economic forecasts that generally envision that economic activity will expand at a moderate pace in coming years, labor market conditions will strengthen somewhat further, and inflation will be at or near 2 percent over the medium term. In short, we currently judge that it will be appropriate to gradually increase the federal funds rate if the economic data continue to come in about as we expect. Indeed, at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate."
Yellen adds, "To conclude, we at the Federal Reserve must remain squarely focused on our congressionally mandated goals. The economy has essentially met the employment portion of our mandate and inflation is moving closer to our 2 percent objective. This outcome suggests that our goal-focused, outlook-dependent approach to scaling back accommodation over the past couple of years has served the U.S. economy well."
Finally, she tells the audience, "[W]e realize that waiting too long to scale back some of our support could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession. Having said that, I currently see no evidence that the Federal Reserve has fallen behind the curve, and I therefore continue to have confidence in our judgment that a gradual removal of accommodation is likely to be appropriate. However, as I have noted, unless unanticipated developments adversely affect the economic outlook, the process of scaling back accommodation likely will not be as slow as it was during the past couple of years."
The WSJ article says, "Federal Reserve Chairwoman Janet Yellen signaled the central bank is on course to pick up the pace of interest-rate increases, with the next rise coming as soon as March and more to come later this year.... An improving economy, firming inflation, and the possibility of more spending and less taxing by the Trump administration appear to have made Fed officials comfortable with nudging rates higher at their next policy meeting March 14-15."
The article explains, "Ms. Yellen's remarks cap a week of similar statements from Fed decision makers suggesting they were leaning toward lifting rates at the coming meeting. On Tuesday, the leaders of the San Francisco and New York Fed banks both spoke of a need to raise rates relatively soon, a message echoed by Fed governors Lael Brainard and Jerome Powell later in the week. Fed Vice Chairman Stanley Fischer chimed in Friday in New York."
It adds, "The Fed has for some time signaled the March meeting was a possible time to boost borrowing costs. Ms. Yellen suggested as much when she told Congress in February that an increase might come "at our upcoming meetings." However, markets only appeared to have taken the message seriously in recent days. On Monday, federal-fund futures tracked by CME Group suggested investors saw a roughly 35% chance of an interest-rate increase this month. That surged to 81.9% by Friday afternoon."
Our Crane 100 Money Fund Index, the average of the 100 largest taxable money funds, has moved up from 0.05% prior to the first Fed move in December 2015, to 0.30% just prior to the second Fed move. It currently stands at 0.48%, and should move up towards 0.73% over the next month or so. Prime Institutional funds, which yielded 0.07% on average before the first Fed hike, and 0.33% before the second hike, now yield 0.56%. (Spreads over Treasury Inst MMFs have risen from 6 basis points, to 18 bps, to 28 bps during this time.)
