Upbeat Fed Cuts Monthly Bond Purchases
The Federal Reserve struck an encouraging note Wednesday: It will further cut its bond purchases because the U.S. job market needs less help. And it said the economy had strengthened after all but stalling during a harsh winter.
The Fed also reaffirmed its plan to keep short-term interest rates low to support the economy “for a considerable time” after its bond purchases end, likely late this year. But it again offered no specific timetable for any rate increase. Most economists expect no rate increase before mid-2015 at the earliest.
The Fed’s guidance on short-term rates conforms to goals that Chair Janet Yellen noted in a speech this month. She said the Fed’s rate policies must be flexible enough to meet unexpected economic challenges.
The Fed’s description of an economy rebounding from the winter freeze was the only meaningful change it made from the statement it issued in March, after the first meeting that Yellen led after taking over in February.
Wednesday’s statement also repeated the theme the Fed sounded in March that even after the job market strengthens and it starts raising rates, it will likely keep rates unusually low to support a still-subpar economy.
Investors had little discernible reaction to the statement. Stock and bond prices both rose modestly.
The Fed’s decision was approved on a 9-0 vote. Narayana Kocherlakota, president of the Fed’s Minneapolis regional bank, supported the action. Kocherlakota had dissented from the March statement because he objected to a change in the Fed’s guidance on rates: He favored lowering the threshold for a possible rate increase to an unemployment rate of 5.5 percent.
Instead, the Fed eliminated its previous 6.5 percent unemployment threshold entirely. It said it instead planned to monitor a range of data to determine the economy’s progress in moving toward the Fed’s dual goal of full employment and inflation rising 2 percent annually. That shift was seen as giving the Fed more flexibility in its policymaking.
Wednesday’s statement was issued the same day that the government said the economy’s growth slowed to a barely discernible 0.1 percent annual rate in the first three months of 2014, the weakest performance in more than a year. Economists blamed mainly the harsh winter and predicted that growth would rebound to a 3 percent annual rate or better in the current quarter. In its statement, the Fed made no specific mention of the anemic growth last quarter.
“It’s in the rear-view mirror,” said Greg McBride, senior financial analyst at Bankrate.com. “We’re one month into the second quarter, and we’ve already seen some indicators that economic growth will get stronger.”
Yellen has tried to convey that the Fed is prepared to respond quickly to changes in the economy. But her emphasis on flexibility can also be tricky. It can leave investors uncertain and fearful of a sudden shift in the Fed’s approach to interest rates.
Yellen’s message marks a shift from the approach her predecessor, Ben Bernanke, took over the past five years. Under his leadership, the Fed sought to be as publicly specific as possible about its intentions. And it did so by focusing primarily on the unemployment rate.
In December 2012, for example, the Fed said it intended to keep its benchmark short-term rate near zero at least as long as unemployment remained above 6.5 percent. The idea was to signal roughly how long the Fed was committed to keeping borrowing rates at record lows to spur spending and economic growth.
Yellen has said the unemployment rate, now 6.7 percent, overstates the health of the job market and economy and that the Fed must assess a range of barometers. She has expressed concern, for example, that a high percentage of the unemployed – 37 percent – have been out of work for six months or more and that pay is scarcely rising for people who do have jobs.
Some economists have expressed concerns that Yellen’s decision to shift away from the Bernanke Fed’s approach of providing specific guideposts for a future rate increase – its “forward guidance” – could end up confusing markets and contributing to unwanted turbulence.
Yellen also faces skepticism from some fellow Fed members on inflation. The Fed becomes concerned if inflation goes too much above or below its 2 percent target. The inflation index the Fed monitors most closely is measuring about 1 percent.
Some critics on the Fed say its efforts to keep rates super-low have elevated the risk of igniting inflation or inflating bubbles in assets like stocks or homes. Others counter that inflation remains too far below the Fed’s target and that rates should be kept historically low.
The Fed has cut its monthly bond buying from $85 billion. If the economy keeps improving, it will likely keep paring its purchases until ending them late this year. The pullback is expected despite tough challenges the economy faces, from a slowing housing recovery to sluggish wage increases to persistent long-term unemployment.
Ian Shepherdson, chief economist at Pantheon Macroeconomics, said in a research note that the Fed doesn’t appear alarmed by signs of weakness in the housing market.
“The Fed does not view ever-increasing home sales as a necessary condition for the gradual normalization of policy,” Shepherdson said.