Last Updated Feb 10, 2016 11:03 AM EST
WASHINGTON - Federal Reserve Chair Janet Yellen said the U.S. economy faces a number of global threats that could hamper growth and compel the Fed to slow the pace of future interest rate hikes.
"We are watching very carefully what is happening in global markets," Yellen said in answering lawmakers' questions after delivering her prepared remarks. "We have not yet seen a sharp drop off in global growth."
Yellen noted ongoing improvements in the labor market as among the reasons she did not believe the Fed would be considering any reductions in short-term rates in the near future.
She highlighted in her semiannual report to Congress the widening fallout from concerns over China's weaker currency and economic outlook, which is rattling financial markets around the world.
Paul Ashworth, chief U.S. economist with Capital Economics, said in a client note that "the Fed does appear to have been spooked by the decline in the renminbi over the past few months," alluding to China's recent moves to reduce the value of its currency.
While the Fed expects to raise interest rates gradually, they are not on any preset course, she said Wednesday. The Fed would likely move slower "if the economy were to disappoint."
In her first public comments in two months, Yellen offered no major surprises. She reiterated the Fed's confidence that the U.S. economy was on track for stronger growth and a rebound in inflation. At the same time, she acknowledged the weaker economic data reported since the start of the year and made it clear the Fed is closely monitoring greater risks from abroad.
"Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers and a further appreciation of the dollar," she said in prepared remarks. "These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices provide some offset.
Yellen did mention to the House Financial Services Committee that it was possible that the recent economic weakness could prove temporary, setting the stage for faster economic growth and a stronger increase in inflation than expected. Should that occur, the Fed will be ready to hike rates more quickly than currently anticipated.
"The actual path of the (Fed's key interest rate) will depend on what incoming data tell us about the economic outlook," she said.
After the Fed began raising rates late last year, economists widely expected the central bank to continue to boost its benchmark rate gradually but steadily, most likely starting in March. But private economists have trimmed their expectation for four quarter-point hikes this year down to perhaps only two, with the first hike not occurring until June at the earliest.
Yellen "acknowledged all the risks to the downside and positives on the upside to the outlook without leaning in any one direction, thus leaving us with a 'let's play it by ear', middle of the road message which I believe is prudent in light of the amount of information still to be seen before they walk into the March meeting," wrote Peter Boockvar, chief market strategist at the Lindsey Group.
Her testimony included her most extensive comments on the situation in China. The data so far do not suggest that the world's second largest economy was undergoing a sharp slowdown, Yellen said. But she added that recent declines in the country's currency have intensified concerns about China's future economic prospects.
"This uncertainty led to increased volatility in global financial markets and, against the background of persistent weakness abroad, exacerbated concerns about the outlook for global growth," Yellen said.
U.S. growth, as measured by the gross domestic product, slowed sharply in the fourth quarter of 2015, dropping to a meager rate of 0.7 percent. Yellen attributed the result to weakness in business stockpiling and export sales. But she noted that economy is being fueled by other sectors including home building and auto sales.
Yellen said that the sharp declines in U.S. stock prices, rising interest rates for riskier borrowers and further strength in the dollar had translated into financial conditions that are "less supportive of growth."
"These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices could provide some offset," she said.
Yellen said that the U.S. labor market remains solid, creating 150,000 jobs in January. That was enough to push the unemployment rate down to 4.9 percent. Inflation, however, has continued to fall below the Fed's target of 2 percent annual price increases. The shortfall has been steeper recently because of the renewed drop in oil prices and stronger dollar, which holds down U.S. inflation by making foreign goods cheaper for American consumers.
But Yellen said the central bank still believes that energy price declines and stronger dollar would fade in coming months. Inflation should also begin to move closer to 2 percent as a healthy labor market pushes up wages, she said. Worker pay has started to show its first significant gains since the Great Recession ended 6½ years ago.
In the question-and-answer period, Texas Republican Jeb Hensarling, the committee's chair, started off a discussion that had lawmakers questioning the Fed's authority and how much oversight Congress should have over the central bank's decisions.
"I think it would be very disruptive to the economy," Yellen said when asked about the potential ramifications of Congress taking away the Fed's ability to raise and lower short-term interest rates.
Yellen said she was not aware of a legal reason that the Fed could not implement negative rates, but added that the central bank had not explored the question.