The Fed will not do anything that will upset financial markets. That’s what investors gathered from Janet Yellen’s speech on Tuesday. Consequently, risky assets, including Indian stocks, rallied on Wednesday. Spending considerable time on global headwinds, Yellen reiterated that the pace of rate hikes will remain gradual—and also said that even if rates were to return to near zero, the Fed would still have the capacity to provide additional monetary accommodation.
It has been argued that the Fed will not be able to intervene effectively if the need arises, because until December there was practically no scope of cutting rates. However, that’s not necessarily the case. The aftermath of the financial crisis showed that the Fed has tools enough in its toolbox—and Yellen has argued that if required, it will be willing to use them again unrestricted by policy rates, even if it entails risks and costs. Financial markets will always like such talk, as we saw today.