Federal Reserve Chair to Congress: ‘U.S. economy has strengthened’

Federal Reserve says things are looking up

U.S. economic growth has strengthened in 2017, signaling the need for gradual interest rate hikes to ensure a continued recovery, Federal Reserve Chair Janet Yellen told lawmakers Wednesday.

Yellen didn’t give specifics on whether the Federal Open Market Committee, or FOMC, will increase interest rates at its meeting, Dec. 12-13. But her prepared remarks before the Joint Economic Committee set the stage for that possibility.

Noting that inflation has remained persistently low, “Additional gradual rate hikes would likely be appropriate over the next few years to sustain the economic expansion,” Yellen testified.

Nothing to cause investor alarm or avarice

Yellen didn’t reveal any big surprises or red flags. In addition to her optimistic take of the economy, Yellen pointed out that job gains were solid, averaging about 170,000 per month from January through October.

The pace is slower than the previous year but is “still above the range” to absorb new employees in the workforce in the years ahead, she said.

Yellen noted that U.S. unemployment fell to 4.1 percent in October, and labor force participation has remained steady in recent years. However, wage growth has been modest.

If the Fed continues to make measured tweaks to monetary policy, the economy and job market will continue improving. That, in turn, will support faster wage and income growth, Yellen said.

Federal Reserve to monitor low inflation

One key issue to watch in 2018 is chronically low inflation.

“Inflation has continued to run below the 2 percent rate that the FOMC judges most consistent with our congressional mandate to foster both maximum employment and price stability,” Yellen said.

She testified that inflation for items other than food and energy has been “surprisingly subdued” for much of the year.

Inflation set to hit 2 percent target

Yellen said “transitory factors” are to mostly to blame for lower inflation readings. However, as those factors subside, Yellen said she expects inflation to reach the Fed’s 2 percent target. The low inflation could indicate an undercurrent of more persistent issues, she added.

A slowdown in GDP growth is another issue to watch. In comparison to past decades, Yellen said this year’s GDP gains have been “disappointingly slow” despite economic expansion.

What’s driving the trend? Older baby boomers are retiring from the workforce, slowing its growth. Also, overall productivity growth has been sluggish in recent years, Yellen said.

To turn GDP growth around, Yellen recommended that Congress adopts policies that “encourage business investment and capital formation, improve the nation’s infrastructure, raise the quality of our educational system, and support innovation and the adoption of new technologies.”

Markets rise enthusiastically following testimony

Following Yellen’s positive take on the economy and job market, bond yields, stocks and the dollar received a boost in initial trading. This continued into Thursday, when the Dow broke the 24,000 mark.

The U.S. 10-year Treasury yield edged by 0.048 to 2.385 percent.

December rate increase should not affect mortgages

Even if the FOMC increases interest rates in December, as many analysts predict, the impact on mortgage rates might be minimal. That’s because the Fed doesn’t set mortgage rates; Wall Street does.

Here’s an example. In December 2015, the Fed increased rates by 25 basis points for the first time in more than a decade. Meanwhile, mortgage rates didn’t rise; they actually dropped more than 50 basis points after the Fed’s hike.

Mortgage rates are determined by the price of mortgage-backed securities (MBS), which are sold on Wall Street. The Fed’s short-term rate actions and outlook on the economy can influence how investors respond to market conditions.

However, long-term, fixed mortgage rates tend to move in tandem with 10-year Treasury bond yields — a longer-term indicator.

What this means for housing

Yellen’s mention of moderate income growth is a key issue that could impact the health of the housing market.

Existing-home prices surged this year due to a lack of homes on the market and massive pent-up buyer demand.

Even if mortgage rates stay low, incomes aren’t keeping pace with higher home prices. And that means potential home buyers, particularly younger, first-time buyers, might have a harder time saving for a down payment or getting approved for a mortgage.

But if mortgage rates increase in 2018, that might compound the affordability crunch even more.

The Mortgage Bankers Association recently forecast higher mortgage rates in 2018 as the Fed reduces its holdings of Treasury securities and mortgage-backed securities. However, MBA predicted 30-year fixed mortgage rates wouldn’t exceed 5 percent.