(March 3): Former Treasury secretary Janet Yellen said, depending on how long the Iran conflict affects the oil market, there will be both a hit to US economic growth and an increase in inflationary pressures, complicating the job for the Federal Reserve (Fed).
“I think the recent Iran situation puts the Fed even more on hold, more reluctant to cut rates than they were before this happened,” Yellen, who’s also a former Fed chair, said via video to a conference Monday in Long Beach, California.
Inflation is already running about a percentage point above the Fed’s target, Yellen noted. President Donald Trump’s tariffs have contributed around half a percentage point of the current 3% pace, she said.
Before the Iran shock, the Fed put itself in a position where policymakers felt they had addressed labour-market weakness and were waiting for inflation to move down.
“But now you’ve got this Iran shock, with oil prices having moved up considerably — we don’t know what’s going to happen in the coming days,” she said, speaking to S&P Global’s TPM26, a shipping industry conference. If the closure of the Strait of Hormuz, through which much of the region’s oil gets shipped, lasts beyond a matter of days then prices may remain elevated or go higher, Yellen said.
Inflation psychology
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Given that the Fed hasn’t yet got inflation back to 2%, “it really has to worry that market participants begin to say to themselves: Yeah they got it down to 3%, but they’re not serious about getting it down to 2%”, she said.
“If psychology of that type takes hold, they’re worried about permanently higher inflation and worsened tradeoffs”, which is why the Fed may be even more on hold, Yellen said.
Apart from the serious risks including the Iran conflict, the former Treasury chief said, “My bottom line is that the US economy is pretty healthy right now, and I’m pretty optimistic about the economic outlook.”
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Yellen also called out a number of Trump administration moves with regard to the Fed. The president’s attempt to remove Governor Lisa Cook was “all but unthinkable”, she said. “The Supreme Court is yet to opine on that, but probably Trump will lose.”
‘Serious blow’
The president “took an unprecedented step in essentially weaponising the Department of Justice against the chair of the Fed”, Yellen said in reference to the DOJ investigation of remarks last year by Jerome Powell about cost overruns in central bank building renovations. Criminal charges would be a “really a huge threat to the independence of the Fed”, she said.
“I believe everybody recognises that this would be a really serious blow to economic policy, it’s something that could be highly inflationary,” she said.
More broadly, the former secretary said that “a lot of President Trump’s initiatives that are unsettling the global economy are showing up as people demanding higher risk premiums on US Treasuries”.
Increased concern with respect to US economic policy has also put “downward pressure on the dollar” and a sense that higher risks “need to be compensated for”, Yellen said.
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