It’s been only weeks since the Fed’s dovish decision in March, so it’s no surprise today’s speech by Yellen didn’t diverge much from the wait and see stance adopted by the FOMC. But the topic of the speech, why rate hikes when they come will likely only be gradual, made it inherently dovish in tone. Yellen cites existing headwinds as reasons wh the current real neutral rate is low, albeit higher than current rates which are designed to close the remaining output gap. But looking ahead, rate hikes will be tempered by spillovers from still tame global growth and its downside pressure on US growth/inflation, and by the low starting point for the fed funds rate, which leaves less room to ease if the economy surprises to the downside.
On the more hawkish side, Yellen isn’t convinced that inflation expectations have fallen as much as market based measures (e.g. those derived from TIPS) suggest, expects that the base case involves a lessening of global headwinds ahead, and does at least mention that there could be upside surprises to either growth or inflation.
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On balance, Yellen has cloaked herself in dovish wings, which at least for April, keeps the Fed on hold, and is consistent with our view that a hike in June could be followed by another long pause. Market reaction will be bullish for short dated bonds, bearish for the USD.