Federal Reserve needs to stay forward-looking, Yellen says

The Federal Reserve needs to remain "forward-looking" when setting policy and to be mindful of the risks that might be inherent in keeping interest rates low beyond their 'past due' date, the head of the US central bank said.

Yellen also appeared to have joined the camp of those who believed that another interest rate hike might be appropriate "relatively soon", with her remarks provoking an immediate reaction from bond markets.

As of 1320 GMT, the yield on the benchmark 10-year US Treasury note was flat at 2.22% but off its intraday low of 2.18% hit earlier in the session.

In a speech prepared for her testimony before the Joint Economic Committee of the US Congress, Janet Yellen said, "were the FOMC to delay increases in the federal funds rate for too long, it could end up having to tighten policy relatively abruptly to keep the economy from significantly overshooting both of the Committee's longer-run policy goals.

"Moreover, holding the federal funds rate at its current level for too long could also encourage excessive risk-taking and ultimately undermine financial stability."

No references were made in the speech to the possible convenience of allowing the labour market too run a little hot or to the results of the past presidential elections.

The decision to keep rates unchanged when policymakers met in September was not out of a lack of confidence in the economy, but because the unemployment rate had remained steady year-to-date despite above-trend gains in jobs, while inflation had continued to run below policymakers´ target.

"At our meeting earlier this month, the Committee judged that the case for an increase in the target range had continued to strengthen and that such an increase could well become appropriate relatively soon if incoming data provide some further evidence of continued progress toward the Committee's objectives," she said.

Her reference to a rate hike "relatively soon" echoed the minutes of the September FOMC meeting, which revealed that "some" participants believed that it would be appropriate to raise the target range for the federal funds rate "relatively soon if the labor market continued to improve and economic activity strengthened".

Nonetheless, only gradual rate increases were still warranted and the risk of 'falling behind the curve' in the near future appeared limited, Yellen added.

"[...] Gradual increases in the federal funds rate will likely be sufficient to get to a neutral policy stance over the next few years.

"Of course, the economic outlook is inherently uncertain, and, as always, the appropriate path for the federal funds rate will change in response to changes to the outlook and associated risks."

"[...] We have no problem with Dr. Yellen's short-term view on policy - the case for hiking has "strengthened" and leaving rates at their current level for too long is risky - but we are concerned that she still thinks rates ultimately won't need to rise far. And when she says that "...the risk of falling behind the curve in the near future appears limited", because inflation will not reach the target for a “couple of years", we get plain nervous.

"We think the core PCE could easily be breached by the middle of next year, just as the Trump stimulus kicks in. That would leave a cautious Fed horribly exposed, and struggling to catch up," said Ian Shepherdson, chief economist at Pantheon Macroeconomics.