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Interest Rate Forecast Outlook

|Includes: SPDR Dow Jones Industrial Average ETF (DIA), QQQ, SPY, USO, UUP
Janet Yellen Feds Next Move

Yellen Says Fed May Start Raising Rates Before U.S. Reaches Growth Targets By The Street

Don't rule out interest-rate increases sooner rather than later: Federal Reserve Chair Janet Yellen said Monday that rates should move up even before the U.S. economy reaches all of the central bank's growth targets.

Since monetary-policy adjustments lag developments in the real economy, withdrawal of "accommodation ought to be initiated" early, she said in a speech in Philadelphia. The central bank chief's remarks are a bellwether for traders and businesses gauging the likelihood that the Fed will follow through on a possible rate hike this month or next after a May jobs report showed a sharp deceleration in growth.

A rate increase in June would be only the second since the Fed cut rates to nearly zero to bolster the economy during the financial crisis of 2008. After the first 25 basis-point boost in December, the central bank had indicated it might raise rates as many as four times this year, then halved the projection amid market swings in January and February related to slowing growth in China and plummeting oil prices.

Still, the U.S. "has registered considerable progress over the past several years toward the Federal Reserve's goals of maximum employment and price stability," Yellen told the World Affairs Council in Philadelphia. "There are good reasons to expect that we will advance further toward those goals."

While a jobs report on Friday that showed growth of only 38,000 positions -- a sharp slowdown from the previous month -- indicates that the labor market bears "close watching," Yellen said she remains optimistic.

"One should never attach too much significance to any single monthly report," she continued. "Other timely indicators from the labor market have been more positive. For example, the number of people filing new claims for unemployment insurance -- which can be a good early indicator of changes in labor market conditions -- remains quite low, and the public's perceptions of the health of the labor market, as reported in various consumer surveys, remain positive."

An increase sooner rather than later would benefit finance companies from JPMorgan Chase (NYSE:JPM) to Bank of America (NYSE:BAC) , whose interest income was eroded by seven years of near-zero rates. Typically, banks are able to buoy that revenue stream by passing on rate increases more quickly to borrowers than to depositors.

The bulk of December's rate increase, for example, stayed with banks rather than being passed on to customers, JPMorgan CEO Jamie Dimon said Thursday at an AllianceBernstein conference.

"I'm a believer we should be raising rates, and I'll leave it to the Fed about the timetable they do that," he said. "They've made it clear that they want to raise rates; they see the whites of the eyes, which are growth and some stronger inflation."

A rate hike would also benefit consumers saving money for retirement and pension funds, which have seen funding gaps widen as returns on the safest investments dwindled.

Among the risks, however, is that rate hikes tend to strengthen the dollar, which typically curbs overseas demand for goods produced in the U.S. by manufacturers such as General Electric (NYSE:GE) and Boeing (NYSE:BA) .

As for timing, Yellen's comments on Friday's jobs data echoed those of Boston Federal Reserve President Eric Rosengren, a voting member of the Fed's monetary policy committee, who spoke in Helsinki earlier in the day.

"It will be important to see whether the weakness in this report is an anomaly or reflects a broader slowing in labor markets," he said.

After the employment figures were released, the odds of a June rate increase fell to 4%, down from 20% at the start of the week, as traders bet that the report would prompt the central bank's monetary policy committee to delay action. Following Yellen's speech, the chances of a June hike fell even further, to 2%, although the likelihood of an increase before year's end rose.

"I expect that further gradual increases in the federal funds rate will probably be appropriate," Yellen said. "What is certain is that monetary policy is not on a preset course, and that the committee will respond to new data and reassess risks so as to best achieve our goals."

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