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 In words that echo those of colleagues on the Fed's dovish wing,
Fed Chair Janet Yellen told a news conference on Wednesday that
"caution is appropriate" when it comes to raising interest rates.
She said she was not convinced underlying inflation had accelerated.
If Yellen is right, financial markets have ample warning for the
gradual pace of rate hikes she said was likely.
But many private economists buy into the argument by an opposing
faction within the Fed that U.S. inflation is indeed stirring.
They point to a range of recent data to back their view, including a
reading Thursday showing underlying U.S. inflation rose 2.3 percent
in the 12 months through February, the biggest increase in more than
three years. The Fed's target is 2-percent inflation.
Faster price gains would likely trigger more aggressive rate hikes
which Yellen in the past has warned could cause a recession.
 "If we got to a point where the Fed had to raise (rates) quickly, it
could be very destabilizing," said Northern Trust economist Carl
Tannenbaum, formerly an economist at the Chicago Fed.
Yellen's comments sounded much like those of a vocal faction of Fed
policymakers, led by Governor Lael Brainard, who have argued
publicly that the global economic slowdown could knock the U.S.
economy off course. Brainard just last week counseled against
assuming that a tighter labor market would boost inflation.
However, the chair's assessment that inflation may not yet have
turned the corner to a more healthy trajectory runs counter to the
view of Fed Vice Chairman Stanley Fischer, who warned this month
that faster inflation might well be stirring.
If Fischer is right, Fed Chair Janet Yellen may have to change her
tone as soon as the next policy meeting in April.
"Yellen will have a noticeable faction of the committee that's
anxious to tighten again," said David Stockton, the Fed's former
research director who is now a fellow at the Peterson Institute for
International Economics. "They will need to be persuaded that the
process is still in place, that this is not an indefinite pause."
DIALING BACK
After Wednesday's decision and fresh forecasts from the Fed that
showed most officials prefer just two rate hikes this year,
investors and economists dialed back their own rate hike
expectations, with traders of interest-rate futures now seeing no
rate rise before September.
The Fed raised its benchmark interest rate by a quarter of a
percentage point in December, the first time it lifted rates in
nearly a decade. Its target now stands as between 0.25 and 0.50
percent.
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With the market view for just one rate hike this year at odds with
the Fed's view that at least two will be needed, Yellen could find
herself in a box particularly if global markets remain relatively
calm and threats to the United States dissipate.
"This could reinforce the market’s belief that a dovish Fed is not
all that interested in walking the talk, and when the June (Fed)
meeting comes around skepticism could still reign” said Scott
Anderson, chief economist at Bank of the West.
Some economists, like JP Morgan's Michael Feroli, have even
concluded that the Fed is "becoming inherently more dovish," for a
number of reasons, including increasing comfort with a tight labor
market.
Yellen sought to discount the significance of the slower path of
rate hikes suggested by the Fed forecasts, saying they should not be
seen as a consensus Fed view.
And she said that the Fed's decision to refrain from noting
"downside risks" to its forecasts reflects the fact that global
economic headwinds could become tailwinds if easing by central banks
abroad successfully stokes growth.
The prospect that inflation could perk up further, Wells Fargo
economist Sam Bullard said, means that "there is risk to the market
having just one rate hike priced in."
But overall the Fed's message remained one of patience, even in the
face of unemployment at near-normal 4.9 percent and signs of
inflation creeping up.
And that suggests that for now, the camp within the Fed advocating a
go-slow approach on rate hikes has won the day.
(With reporting by Lindsay Dunsmuir and Howard Schneider in
Washington and Ann Saphir in San Francisco; Editing by Diane Craft)
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