A one-word change in Yellen's remarks could have big implications for interest rates

Federal Reserve Chair Janet Yellen's increasing concern over low and falling inflation helped US stock markets hit record highs last week, in what has become a regular occurrence that has investors increasingly worried about a bubble in equity markets.

Yellen testified before Congress for two days, and Wall Street found enough reticence in her confidence that inflation will in fact head back up toward the Fed's 2% target to justify renewed market bullishness.

Yellen, as she has in other statements recently, told lawmakers that she expects low inflation to be transitory. "Temporary factors appear to be at work. It's premature to reach the judgment that we're not on the path to 2% inflation over the next couple of years," Yellen said.

Crucially for the market, however, she reiterated that "it's something we're watching very closely, considering risks around the inflation outlook."

Thomas Simons, economist Jefferies, believes a single word shift in Yellen's description of inflation spoke volumes into her potential openness to a pause in interest rate increases, which began in December 2015 and have brought the central bank's official interest rate target to a 1% to 1.25% range following the latest June hike.

"Yellen's comments before Congress this past week were significantly more dovish about inflation and rate normalization than either her June 14 press conference or the text of the Monetary Policy Report released just a few days prior to her testimony," Simons said.

"The change in Yellen's description of the recent inflation deceleration from 'idiosyncratic' to 'unusual' was both a preview to Friday's CPI data release and a signal that the inflation picture has been elevated from an annoyance to a source of concern that is making it difficult for policymakers to come to an agreement on the detail of the Fed's normalization efforts."

The consumer price index held steady in June, and the annual rate slipped further below the Fed's target to just 1.6%. The Fed's preferred inflation measure, the personal consumption expenditures index, also recently fell to a six-month low of 1.4%.

The combination of Yellen's focus and the dismal CPI data takes our expectation for a September rate hike off the table," Simons added. "A December rate hike is still on the table, but is also dependent upon the appearance of some stability on the inflation picture."

Dallas Fed President Robert Kaplan seems to be edging closer to the view of Neel Kashkari, the Minneapolis Fed president who has dissented twice this year against Fed rate hikes, wanting to wait for further evidence of inflation and wage growth.

Kaplan is now saying the inflation outlook gives him pause about additional rate rises.

"I would like to see some greater evidence that we are making progress toward meeting our 2 percent inflation objective in the medium term," he said in an essay published July 13. "Future removals of accommodation should be done in a gradual and patient manner."