Fed Chair Yellen has begun day 2 of testimony. She stated today that risks to inflation are two-sided she noted. On one hand prices have been tame, but the tight labor market may eventually push up wages and prices. Yet, given the low inflation readings of late, the Fed believes it’s prudent to stay on a gradual path. She reiterated that it is premature to say the underlying price trend is below 2%. Were the inflation evaluation to change, the Fed would alter its stance. There hasn’t been a conflict between the Fed’s two mandates. She also doesn’t see the economic expansion ending anytime soon.
Regarding the balance sheet, Fed’s intention is to shrink the balance sheet in a “slow, gradual, and prediciable way. Fed has set out a detailed plan on how it will achieve that. Once triggered, the unwind is expected to run in the background. The run off should result in some increase in long term rates compared to the front end, she acknowledged, and the FOMC will take that into account as it sets the funds rate. She expects the funds rate to remain the principal tool of monetary policy. She repeated that the balance sheet and the quantitiy of reserves will be reduced over the next several years, but won’t go back to the pre-crisis levels.
The EURUSD struggles to stay above 1.1400 level during the testimony, since it reached 1.1389 low. Also, the dollar largely shrugged off the data earlier, which saw jobless claims fall less than expected, headline PPI a touch warmer, and core PPI a tick cooler than forecast.
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