Fed Changes Interest Rate Policy, Linking to Wider Data Range

At Fed meeting, Janet Yellen's first as chairman, committee members drop 6.5% unemployment rate as prime trigger for raising rates

Fed chief Janet Yellen. (Photo: AP) Fed chief Janet Yellen. (Photo: AP)

The Federal Reserve gave itself room to keep borrowing costs low at least until next year by dropping a linkage between the benchmark interest rate and a specific level of unemployment.

“A highly accommodative stance of monetary policy remains appropriate,” the Federal Open Market Committee said in a statement on Wednesday following a meeting in Washington that was the first led by Chair Janet Yellen. In determining how long to keep rates low, the committee will assess progress towards its goals of maximum employment and 2 percent inflation, it said.

That assessment takes into account a “wide range of information,” including labor market conditions, inflation expectations and financial markets. The Fed also reduced the monthly pace of bond purchases by $10 billion, to $55 billion.

The Fed is overhauling forward guidance after unemployment declined toward 6.5 percent, its previous threshold for a rate increase, faster than policy makers predicted. Yellen last month told lawmakers that the unemployment rate alone isn’t an adequate gauge of economic health and “there’s a great deal of slack in the labor markets still that we need to work to eliminate.”

Stocks and Treasuries declined as the Fed’s new forecasts showed more officials predicting the benchmark rate, now close to zero, would rise at least to 1 percent at the end of 2015 and 2.25 percent by the end of the following year.

Yellen News Conference

Yellen, in a news conference, played down the importance of the forecasts, saying they are not as important as the FOMC statement.

“These dots are going to move up and down over time,” she said in a reference to the forecasts, which are illustrated as dots on a chart. They moved up “ever so slightly,” she added. “The committee’s views on policy will likely evolve.”

The FOMC repeated that it will reduce asset purchases “in further measured steps at future meetings.” At the same time, “asset purchases are not on a preset course.” The committee announced $10 billion reductions in purchases at the previous two meetings.

“Growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions,” the Fed said. Even so, “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor-market conditions.”

Consumer Prices

The central bank’s preferred gauge of consumer prices climbed 1.2 percent in the year through January and hasn’t exceeded its 2 percent goal since March 2012. That gives policy makers “ample scope to continue to try to promote a return to full employment,” Yellen testified to lawmakers Feb. 27.

Minneapolis Fed President Narayana Kocherlakota dissented, saying the statement “weakens the credibility of the committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.”

Seventy-six percent of economists in a Bloomberg survey March 14-17 predicted the Fed would drop its unemployment threshold. Economists also predicted a $10 billion reduction in the monthly pace of bond purchases, according to the median of responses.

Yellen, 67, took over as Fed chair last month after three years as deputy to Ben S. Bernanke. In that role, she helped shape the communications policies the Fed wielded as it sought to nurture a recovery from the worst recession since the Great Depression.

Zero Rates

After cutting interest rates to zero in 2008, the Fed embarked on large-scale asset purchases as well as forward guidance intended to convince investors that borrowing costs would stay low for a long time.

Starting in December 2012, the FOMC said the federal funds rate would stay low at least as long as unemployment was higher than 6.5 percent and the outlook for inflation didn’t exceed 2.5 percent.

With the jobless rate at 6.7 percent last month, that guidance was fast becoming obsolete.

“It’s a relic of days of yore,” Brian Jacobsen, who helps oversee $241 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin, said before the FOMC statement.

Policy makers met this week as economic reports indicated the world’s largest economy is pulling out of a slowdown linked to unusually harsh winter weather.

Production Rises

Factory production rose in February by the most in six months as assembly lines churned out more cars, business equipment and chemicals, a month after snowstorms hampered deliveries of parts and materials.

Employers last month added more workers than projected following the weakest two-month hiring gain in more than a year. The jobless rate rose from 6.6 percent, a five-year low, as more people entered the workforce.

Retail sales climbed in February for the first time in three months, claims for unemployment benefits declined and consumer confidence improved, reports showed last week.

“The economy is getting better, and it’s likely the softer patch we’re seeing is weather related,” Josh Feinman, the New York-based global chief economist for Deutsche Asset & Wealth Management and a former Fed senior economist, said before the statement. “I don’t know that all the headwinds are gone, but they’re clearly blowing with a lot less intensity.”

Stock Gains

Consumers are getting a boost from stock-market gains fueled by the Fed’s unprecedented stimulus. The Standard & Poor’s 500 Index jumped 30 percent last year for the best advance since 1997.

“The consumer, as far as the disposable income, is improving a little bit,” Larry Young, chief executive officer of Plano, Texas-based Dr Pepper Snapple Group Inc., the third-largest U.S. soda maker, said at a March 12 investor conference. “We are seeing a pickup.”

As the economy improves, the Fed is slowly scaling back the large-scale bond purchases that have expanded its balance sheet to a record $4.18 trillion. The purchases have prompted concern among some policy makes that the Fed is fueling asset-price bubbles.

The Fed on Dec. 18 announced its first reduction in bond purchases, to $75 billion from $85 billion, then followed up with an equal cut in January to $65 billion.

“The task for monetary policy will be to provide continued support as long as necessary, and to return policy to a normal stance over time without sparking inflation or financial instability,” Fed Governor Jerome Powell told lawmakers last week. “This will require a careful balancing, as there are risks from removing monetary accommodation too soon as well as too late.”

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