As expected, at the March meeting of the Federal Open Market Committee, Federal Reserve policymakers decided to lower the central bank’s monthly monetary stimulus by another $10 billion a month in April — which places bond purchases at $55 billion. “A highly accommodative stance of monetary policy remains appropriate,” read the FOMC statement released Wednesday. What was more hotly anticipated by the market was how Fed Chair Janet Yellen — who served for three years as the vice chair of the central bank before replacing Ben Bernanke last month — would explain the central banks’ reasoning for keeping the benchmark interest rate, or federal funds rate, low.
Ahead of the two-day meeting, RDQ Economics’ Conrad DeQuadros noted that the Fed had put itself in “a little bit of a tricky situation” by justifying the need for continued low short-term interest rates despite the fact that unemployment has dropped faster than expected.
Since December, the central bank has been winding down its extraordinary economic stimulus program; the effectiveness of the Federal Reserve’s highly accommodating monetary policy was diminishing, and policymakers were well aware of that fact. Originally, the Fed began its assets purchases as a means to push down long-term borrowing rates so as to spur investing and hiring. Monetary stimulus was beginning to service an unproductive addiction to easy money more than the favorable dynamic of job creation, rising income, and increased spending that Yellen described in a November congressional hearing. For that reason, and because the economy was soldiering through a slow but real recovery, the FOMC announced at the conclusion of its December meeting that it would reduce the flow rate of assets being purchases for quantitative easing.
But there was still the question of the federal funds rate, which have been held near zero by the Fed since late 2008. In December of 2012, policymakers announced that they would not consider raising the benchmark interest rate until the unemployment rate fell to 6.5 percent, and as long as inflation seemed likely to remain below 2.5 percent. But Fed officials now believe the headline unemployment rate is too limited an indicator of the health of the labor market. The rate of joblessness has fallen to 6.7 percent in recent months, meaning it is extremely close to the Fed’s targeted rate.
Yet, Yellen thinks the economy is still far too weak to increase rates. It is true that declines in the unemployment have come in a large part because because many out-of-work Americans have become discouraged and stopped looking for work, which means they are no longer part of the labor force and no longer counted as unemployed. As of February, 3.8 million Americans were unemployed for at least six months, and 7.2 million workers were stuck in part-time jobs even though they would prefer full-time employment.
Still, “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor-market conditions.” Yellen said in a press conference after the meeting. It is because of the complicated nature of the labor market recovery that the Fed needed to find new language to define the forward guidance on interest rates.
The benchmark interest rate will stay near zero, “well past” the time unemployment rate hits 6.5 percent. Fed policymakers said that instead of targeting a particular jobless rate target the central bank will “assess progress … toward its objectives of maximum employment and 2 [percent] inflation” in deciding when to raise rates from near zero. To make that assessment, the Fed will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments,” the statement read. This marks the first time that the Fed has said explicitly that short-term interest rates will be held lower than normal even after inflation and employment return to their pre-recession trends.
Projections released Wednesday indicated that rates would likely be increased sometime in 2015. “On our present path … we would be looking at next fall,” Yellen said at a press conference after the meeting, referring to interest rates. “What the committee is expressing here, I would say, is its forecast of what will be appropriate some years from now, based on the understanding that we have developed about what are the economic forces that have been driving economic activity. We have had a series of years now in which growth has proven disappointing.”
In particular, the Fed noted that economic activity slowed during the winter months — weakness that in part reflected adverse weather conditions.
“What the statement is saying is it depends what conditions are like,” the Fed Chair explained. “We’d need to see where the labor market is, how close are we to our full employment goal; that will be a complicated assessment, not just based on a single statistic. And how rapidly are we moving toward it? Are we really close and moving fast? Or are we getting closer but moving very slowly?” But basically, “it will be a considerable period after the asset purchase program ends before it will be appropriate to begin to raise rates,” she added.
Yellen stressed that the new guidance does not indicate any change in the policy intentions of the FOMC. Rather, it reflected the changes in economic conditions.
The Fed Chair may have spoken for an hour, but the market only heard three words. When asked how long the central bank would wait to hike rates after the tapering of its monetary stimulus is concluded, she answered with several sentences. “So the language that we used in the statement is ‘considerable period.’ So I, you know, this is the kind of term it’s hard to define,” she responded. “But, you know, probably means something on the order of around six months, that type of thing.” Yellen also added numerous qualifiers, including further improvements in the labor market, determine the outlook on inflation. But the markets only heard “around six months.”
For now, tapering is on course to end in October or November, and a six-month waiting period, puts the first rate hike in April or May. After her comments, both stocks and Treasury bonds declined. The 10-year note yield increased 10 basis points to 2.77 percent, while the Standard & Poor’s 500 Index fell 1.1 percent to 1,852.68.
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