She added that monetary policy is not on a preset course. “We’re watching this very closely and stand ready to adjust our policy if it appears the inflation undershoot appears consistent.”

Markets took Yellen’s comments on inflation and on the Fed’s neutral rate to be dovish for interest rates. The Fed chair said while the Fed expects the neutral rate to rise, it won’t rise to historic levels, meaning the Fed won’t have to hike that much. The neutral rate is the level where rates do not either drive or hold back the economy.

The stock market rallied, pushing the Dow to a record high, and bonds also rallied, with yields falling. The 10-year Treasury was yielding 2.32 percent in afternoon trading, after falling below 2.30 percent initially when Yellen’s prepared remarks were released.

The Fed has targeted a 2 percent inflation rate. Its preferred inflation measure, the PCE deflator, was at 1.4 percent in May after briefly rising above 2 percent in February, thanks to a comparison with last year’s weaker energy prices.

Core CPI had been running above 2 percent throughout last year, but dipped several months ago and remains low. Economists expect core CPI to rise by 0.1 percent in June, or a 1.7 percent pace year-over-year.

“CPI core was above 2 percent for like 15 months in a row and the irony is the Fed never tightened through that,” said Peter Boockvar, chief market analyst at Lindsey Group. The Fed’s dual mandate is full employment and steady prices, and while the job market has been strong, inflation has been the laggard.

Boockvar isn’t optimistic for an improvement soon. “I think food prices all of a sudden could replace energy prices as an influence on headline inflation,” said Boockvar. Agricultural commodities have been rallying, and analysts expect those increases to show up in food prices.

Boockvar said the market ignored Yellen’s comments Wednesday on the Fed’s balance sheet unwind, which he said would be like a form of tightening. Strategists said interest rates could rise as the Fed slows down purchases of Treasurys and mortgages to replace those on its balance sheet that are expiring. The Fed has said it would pause its rate hikes while it starts the process.

That program is the last vestige of the Fed’s quantitative easing programs, which were asset purchases used to keep long-end interest rates low. The Fed’s balance sheet is about $4.5 trillion, and it’s expected to eventually shrink it by $1 trillion.




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