Fed, in monetary policy report, says valuations stretched for smaller social media & biotech stocks

The economy continues to improve but the recovery is not yet complete, Fed Chair Janet Yellen said on Tuesday.

While Yellen’s remarks were mostly benign and cautious on the economy, a separate Federal Reserve report indicated concern over asset prices

“Valuation metrics in some sectors do appear substantially stretched—particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year,” said remarks in the full policy report accompanying Yellen’s testimony.

The comments gave the market some pause, sending shares in Yelp, for instance, down more than 4 percent.

In prepared remarks ahead of semi-annual testimony to Congress, Yellen said there were signs of a production and spending rebound in the second quarter, but “this bears close watching.”

Yellen also noted that housing activity has been disappointing, with the sector showing “little progress” of late with readings this year “disappointing” as mortgage rates have edged higher.

The remarks were part of what once was known as the “Humphrey Hakwins” testimony in which the central bank chief apprises lawmakers of the state of policy and the U.S. economy. Yellen’s testimony comes as the Fed looks to end its monthly bond-buying program—currently at $35 billion—and contemplates when to begin raising short-term interest rates from near-zero levels.

Read More Looks like the Fed wants to have even more power

“The economy is continuing to make progress toward the Federal Reserve’s objectives of maximum employment and price stability,” Yellen was to say, according to prepared remarks.

Though the economy slumped 2.9 percent in the first quarter, Yellen continued to insist that factors contributing to the decline in gross domestic product were an aberration unlikely to be repeated.

“The decline appears to have resulted mostly from transitory factors, and a number of recent indicators of production and spending suggest that growth rebounded in the second quarter, but this bears close watching,” she said.

Economic activity probably will grow at “a moderate pace over the next several years”—a comment that would help the Fed justify its extreme monetary accommodation even though the financial crisis-inspired recession ended five years ago and the stock market, as measured by the S&P 500 index, has gained 197 percent since its March 2009 low.

Other gauges on economic strength have not been as positive. Unemployment is at 6.1 percent, but job creation has been titled toward part-time positions and long-term employment remains a challenge. Wages have stagnated even as energy and food costs have escalated significantly.

Still, the jobless rate already has hit the Fed’s estimate for the year and is well below the original 6.5 percent target it had set before considering a rate hike. Inflation, as measured through the personal consumption expenditures index, remains below the Fed’s target.

This is breaking news. Check back for updates. 

Read More Yellen expected to offer up good news

Fed watchers did not expect much new from Yellen in her testimony before the Senate Banking Committee at 10 a.m. ET, her first day of two days of economic testimony on Capitol Hill.

The Fed did reveal in the minutes of its last meeting that it expects to end its quantitative easing bond-buying program in October.

“I don’t think she’ll stray from the script,” RBS credit strategist Edward Marrinan said ahead of the testimony, adding she will choose her words carefully and avoid any time frames on policy that are not public. Marrinan said he expects to see the first rate hike between June and September next year.

Read More Looks like the Fed wants more power

But since the June jobs report was released, the varied views on Wall street about when the Fed will start to raise rates have changed, with some bringing expectations forward.

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