Fed Says Economy Rebounding as It Trims Bond Purchases

But Yellen warns that the job market is still weak

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

The Federal Reserve said growth is bouncing back and the job market is improving as it continued to reduce the monthly pace of asset purchases.

“Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace thereafter,” Federal Reserve Chair Janet Yellen said at a press conference in Washington today following a meeting of the Federal Open Market Committee. Even with declines in unemployment, “a broader assessment of indicators suggests that underutilization in the labor market remains significant.”

The FOMC trimmed bond-buying by $10 billion for a fifth straight meeting, to $35 billion, keeping it on pace to end the program late this year.

Yellen and her fellow policy makers are debating how long to keep interest rates near zero as the U.S. labor market improves and inflation moves closer to the Fed’s 2% goal.

The policy-making FOMC repeated today that it’s likely to “reduce the pace of asset purchases in further measured steps” and that it expects rates to stay low for a “considerable time” after the bond-buying ends.

Stocks advanced after the Fed announcement, with the Standard & Poor’s 500 index rising 0.6% to 1,952.83 as of 3:19 p.m. in New York. Ten-year Treasury yields fell five basis points to 2.60%.

Updating their economic forecasts, Fed officials predicted their target interest rate will be 1.13% at the end of 2015 and 2.5% a year later, higher than previously forecast. They lowered their long-run estimated rate to 3.75% from 4%, reflecting slower long-term growth for the U.S. economy. Fed participants estimated long-term growth at 2.1% to 2.3%, compared with 2.2% to 2.3% in March.

Stocks Gain

“Inflation has continued to run below the committee’s 2% objective,” Yellen said, and low inflation “could pose risks to economic performance.” At the same time, longer-term expectations are still “well-anchored.”

The personal consumption expenditures index, the Fed’s preferred inflation gauge, rose 1.6% from a year earlier in April, the most since November 2012. The consumer price index, a separate inflation measure, rose 2.1% in May.

Treasuries, MBS

The Fed will divide its bond purchases between $20 billion in Treasuries and $15 billion in mortgage-backed securities beginning in July, the FOMC said in its statement.

Yellen said policy makers are discussing a new set of principles to guide an eventual exit from record easing and expects to announce them later this year.

“The committee is confident it has the tools it needs to raise short-term interest rates” when necessary, she said. The Fed “will continue to have a very large balance sheet for some time.”

Three rounds of large-scale asset purchases intended to hold down long-term interest rates have swelled the central bank’s balance sheet to a record $4.34 trillion. Fed officials are testing tools that will be needed to tie up excess reserves in the banking system, a step they will have to take in order to raise short-term rates.

Steady labor-market gains have bolstered confidence among policy makers that they can wind down asset-buying without endangering the five-year expansion.

Unemployment (USURTOT) held at 6.3% in May, the lowest in almost six years, and payrolls increased by more than 200,000 for a fourth consecutive month, the first time that’s happened since early 2000.

Continued Weakness

Some measures of employment watched by Yellen show continued weakness. The so-called participation rate, which shows the share of working-age people in the labor force, held at 62.8%, matching the lowest since March 1978.

Policy makers are counting on a faster expansion to pull more people back into the labor force. The pace of growth will exceed 3% in the final three quarters of the year, according to economists surveyed by Bloomberg, after a 1% first-quarter contraction caused in part by harsh winter weather.

Manufacturing grew in May at the fastest pace this year, according to data from the Institute for Supply Management. The ISM’s service-industry gauge showed the strongest expansion since August.

“We’ve seen quite the decent rebound in the second quarter, but more importantly, the momentum is building for the second half,” said Ian Shepherdson, chief economist at Pantheon Macroeconomics in White Plains, New York.

Home Construction

Recent reports show that residential construction is stabilizing after it subtracted from growth over the past two quarters.

Builders broke ground last month on 1 million homes at an annualized rate after 1.07 million in April, the best two-month reading since late 2013.

Residential construction is boosting United Technologies Corp., the Hartford, Connecticut-based maker of Carrier air conditioners and Otis elevators. “The U.S. economy feels pretty good,” Chief Financial Officer Greg Hayes said at a June 5 investor meeting. “We still think there’s good momentum,” he said, citing growth in the company’s residential businesses.

The quickening economy and better-than-estimated corporate earnings have pushed up U.S. stocks to new highs. The S&P 500 Index yesterday closed near the record level reached on June 9.

“The committee doesn’t try to gauge what is the right level of equity prices,” Yellen said today. Rather, it looks to see if valuation levels “are outside of historical norms. I still don’t see that broadly.”

Low Volatility

The Chicago Board Options Exchange Volatility Index, a gauge of S&P 500 swings, fell to the lowest since early 2007. Foreign-exchange volatility also has slowed, falling to an almost seven-year low.

Low financial-market volatility has stirred concern among some policy makers. New York Fed President William C. Dudley said last month it may signal investor complacency about risk, making him “a little nervous.”

The FOMC gained three new voting members for this meeting. The U.S. Senate voted last week to approve the nomination of Lael Brainard, former U.S. Treasury undersecretary for international affairs, as a governor. It also approved Stanley Fischer as vice chairman. Loretta Mester on June 1 succeeded Sandra Pianalto as president of the Cleveland Fed.

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