Tags: Fed Debate Shifts to Tightening Pace After First Rate Increase

Fed Debate Shifts to Tightening Pace After First Rate Increase

Thursday, 20 November 2014 12:16 PM

U.S. central bankers are weighing whether they should communicate more of their views about the probable pace of interest-rate increases after they lift off zero next year.

“A number of participants thought that it could soon be helpful to clarify the committee’s likely approach” to the pace of increases, according to minutes of the Oct. 28-29 Federal Open Market Committee meeting released in Washington.

The discussion last month underscored how much officials will rely on forward guidance on the pace of tightening in the future. After bond purchases ended last month, guidance may be the most practical option left to assure investors that policy won’t become overly restrictive if officials decide to take a stand against inflation seen as too low.

The pace of rate increases is “going to be slow until they are really convinced that inflation’s sustainably at target and the labor market’s in really, really good shape,” said Guy Berger, a U.S. economist at RBS Securities Inc. in Stamford, Connecticut. “They are going to take their sweet time.”

The minutes showed that many FOMC participants last month felt the committee should stay on the lookout for signs that inflation expectations were declining.

Declining expectations could herald an actual fall in prices. Such deflation does economic damage by encouraging consumers to delay spending in anticipation of lower prices in the future.

The potency of the first rate increase could be diminished or increased, depending on what the FOMC says about how it views its subsequent moves, said Laura Rosner, U.S. economist at BNP Paribas SA in New York.

Limit Tightening

“It isn’t just the timing of liftoff the Fed cares about, but the whole path of federal funds rate,” said Rosner, a former New York Fed staff member. “I think they do probably want to limit the extent of tightening that people expect, at least at the beginning.”

While telegraphing the future rate path may be attractive to some officials, it may also be unpopular with those, such as Chair Janet Yellen, who recall the Fed’s experience in 2004 with language saying the pace of increases would be “measured.”

Household savings rates dropped, borrowing against home equity soared and mortgage credit quality weakened as the Fed ruled out the possibility of aggressive interest-rate increases, helping to pave the way for the 2008 financial crisis.

At her September press conference, Yellen stressed that changes in the rate will be data dependent.

Posing Challenges

The October minutes said “it was noted” -- language that some analysts suggests refers to the chair -- that “communication about post-liftoff policy would pose challenges given the inherent uncertainty of the economic and financial outlook and the committee’s desire to retain flexibility to adjust policy in response to the incoming data.”

Most officials supported the current statement language that economic conditions may warrant keeping “the target range for the federal funds rate below longer-run normal levels even after employment and inflation are near mandate-consistent levels.”

Fed officials’ quarterly economic forecasts make some of that foot-dragging on policy normalization explicit.

For example, officials expect the U.S. to be at what they regard as full employment in the final quarter of 2016, according to projections the Fed released in September.

Neutral Level

At that point, their median forecast for the main rate is 2.875 percent, almost a percentage point below the 3.75 percent rate that officials estimate to be the so-called neutral level of the federal funds rate, which they say keeps inflation and employment in balance.

Put another way, if the committee starts raising rates in June and follows the path described by their latest median projections, it would take 2-1/2 years to increase rates from zero to 3.75 percent.

Investors are projecting an even slower pace of rate increases, suggesting they are more pessimistic about growth next year than the Fed and may view too-low inflation as a stubborn problem.

Eurodollar futures imply the Fed will raise the benchmark rate around 0.25 percent per quarter between the third quarter of next year and the first quarter of 2017. The rate will only rise to a range of 2.25 percent to 2.50 percent by the end of 2017, versus the median Fed official’s 3.75 percent estimate.

By comparison, in the last tightening cycle, the committee raised the federal funds rate from 1 percent in June 2004 to 5.25 percent in June 2006, closing a larger gap in less time.

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To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Matthew Boesler in New York at mboesler1@bloomberg.net To contact the editors responsible for this story: Chris Wellisz at cwellisz@bloomberg.net Alister Bull

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Fed Debate Shifts to Tightening Pace After First Rate Increase
Fed Debate Shifts to Tightening Pace After First Rate Increase
Thursday, 20 November 2014 12:16 PM
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