Fed tells Congress: "not yet"

In her semi-annual Humphrey-Hawkins testimony to the Senate (she gets to do it all over again for the House on Wednesday), Fed Chair Janet Yellen indicated that interest rate hikes are still some months away: the central bank is going to remain "patient".  Some members of Congress, especially on the Republican side, are concerned that the Fed may wait too long, only to have to push rates up quickly if inflation rears its head.

It appears that the recent decline in the headline inflation rate, thanks to the collapse in energy prices, has emboldened the Fed to stand pat for a little longer. Over in London, Bank of England Governor Mark Carney recently signalled a similar outlook for UK monetary policy, and as there is zero prospect of rate rises at any of the other major central banks -- the BoJ, the ECB, the RBA -- it looks as though we will be waiting until after mid-year to find out whether anyone really knows how to unwind the stimulus that's now been in place for well over half a decade.

The fact that the Fed is using the low headline CPI as a key justification for standing pat is a little worrisome. Ms Yellen's predecessor-but-one, Maestro Greenspan, was notorious for casting around to find new inflation measures to justify his own predilection for low interest rates.  Remember the ECI (employment cost index)? Or how about the core personal consumption expenditure deflator? Greenspan relied on both of these, and many others besides, at one time or another. In the meantime he applied unnecessary monetary stimulus to the economy, leading to the disastrous consequences that unfolded from 2007 to 2009.

It's unlikely that Ms Yellen is making the same mistake. At the same time, it's hard to avoid the thought that if you really could achieve solid growth with low inflation simply by opening the monetary spigot as wide as possible, somebody would have figured that out years ago. These are extraordinary times, and it's unlikely that getting back to "normality" will be easy or predictable.  Ms Yellen correctly noted that the US employment picture has improved on all fronts since her last appearance before Congress.  Even so, wage pressures remain under control, largely as a consequence of the drastically reduced bargaining power of American workers. There's no imminent suggestion that that's about to change -- though WalMart's decision to boost the pay of all of its "associates" may have a ripple effect -- but it's certainly a key area of risk that the Fed will need to monitor closely.

And what does this mean for Canada?  Bank of Canada Governor Poloz is widely expected to cut rates again next month, and that prospect, together with Ms Yellen's generally upbeat take on the US economy today, is putting the Canadian dollar under renewed pressure. The rapid falls in gasoline prices that we saw a couple of months ago are already starting to reverse themselves, and the currency's sharp decline will add to price pressures at the consumer level in the coming months.  The Bank has warned that headline CPI might slip into negative territory in the spring, but it's unlikely to stay there for very long. Even so, and especially with an election coming in October, rate hikes in Canada are likely to lag the Fed by many months.