Fed on track to hike rates as economic headwinds wane -Yellen

By Jonathan Spicer and Michael Flaherty

PROVIDENCE, R.I. (Reuters) - Federal Reserve Chair Janet Yellen was clearer than ever on Friday that the central bank was poised to raise interest rates this year, as the U.S. economy was set to bounce back from an early-year slump and as headwinds at home and abroad waned.

Yellen spoke amid growing concern at the Fed about volatility in financial markets once it begins to raise rates, and a desire to begin coaxing skeptical investors towards accepting the inevitable: that a 6-1/2-year stretch of near-zero interest rates would soon end.

In a speech to a business group in Providence, Rhode Island, Yellen said she expected the world's largest economy to strengthen after a slowdown due to "transitory factors" in recent months, and noted that some of the weakness might be due to "statistical noise."

The confident tone suggested the Fed wants to set the stage as early as possible for its first rate rise in nearly a decade, with Yellen stressing that monetary policy must get out ahead of an economy whose future looks bright.

While cautioning that such forecasting is always highly uncertain, and citing room for improvement in the labor market, the Fed chief said delaying a policy tightening until employment and inflation hit the central bank's targets risked overheating the economy.

"For this reason, if the economy continues to improve as I expect, I think it will be appropriate at some point this year to take the initial step to raise the federal funds rate target," and begin normalizing monetary policy, Yellen told the Providence Chamber of Commerce.

In a speech in March, Yellen said only that a rate hike "may well be warranted later this year," though the Fed was at the time giving "serious consideration" to making the move.

Investors globally are attempting to predict when the Fed will modestly tighten policy. Most economists point to September, while traders in futures markets held firm on December.

Ahead of a three-day U.S. holiday weekend, Treasury yields hit session highs after Yellen spoke on Friday, and short-term interest rate futures extended losses, hitting session lows. U.S. stocks were largely flat.

"This is probably the most telegraphed Fed lift-off in some time," said Bruce Zaro, chief technical strategist at Bolton Global Asset Management. "I think they're concerned about the market's reaction - they don't want to have a period of volatility that causes the market to react in a crash-type form."

Yellen, however, struck some familiar dovish chords, noting that the "generally disappointing pace of wage growth ... suggests that the labor market has not fully healed."

She said less progress had been made on lifting inflation, though she said the Fed believes it will rise to the central bank's medium-term 2 percent goal as oil prices rebound and other temporary factors dissipate.

"With the waning of the headwinds ... the U.S. economy seems well-positioned for growth," Yellen said, predicting "moderate" employment and output growth this year and beyond.

She also reinforced the notion that rate hikes will depend on incoming economic data and that the tightening process, once it begins, is likely to be gradual.

"Yellen believes the economy is improving and that the Fed will raise rates this year," said Wayne Kaufman, chief market analyst at Phoenix Financial Services. "It is just waiting for the right data to do that."

(Reporting by Michael Flaherty and Jonathan Spicer; Additional reporting by Howard Schneider in Washington and the New York markets team; Editing by Paul Simao)