Markets cheer Yellen's caution

Markets around the world have rallied after Federal Reserve chairman Janet Yellen told the United States Congress on Wednesday that the central bank would likely pursue a "gradual" tightening of monetary policy in the next few years.

Investors have taken this to mean that the Fed will go slower than previously expected on further interest rate hikes, keeping liquidity flowing through the markets.

United Overseas Bank economists said on Thursday that Dr Yellen made an important point when addressing the uncertain US inflation outlook.

Dr Yellen explained that some temporary factors appear to be at work in holding down inflation, which has been unusually low for several months.

She said it was premature to reach the judgment that the US is not on track to reach its target of 2 per cent inflation over the next few years.

But Dr Yellen added that monetary policy was not on a preset course, and that the Fed was "watching this very closely and stands ready to adjust our policy if it appears the inflation undershoot appears consistent".

If low inflation persists, the Fed would have to stay its hand even longer, keeping interest rates near historic lows to encourage business and consumer spending and, in turn, price increases - a sign that economic activity is on a healthy growth cycle.

All this has caused jubilation in the financial markets. Commodities such as gold have rallied, as have equity markets from Wall Street - where the Dow Jones Industrial Average reached a fresh high - to Asia, where stocks had their best week since March.

Amid the bullish backdrop, investors will likely be parsing the latest US inflation data, released last night, for more signs as to how the Fed will proceed.

As Societe Generale strategist Kit Juckes told Bloomberg: "If we trundle along with the current level of inflation, the Fed won't stop slowly raising rates, but they won't be in any hurry."

A version of this article appeared in the print edition of The Straits Times on July 15, 2017, with the headline 'Markets cheer Yellen's caution'. Print Edition | Subscribe