Fed Sees Labor-Market Slack Even as It Trims Bond Purchases

Central bank officials stepping up debate on when to raise interest rates

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

The Federal Reserve said slack in the labor market persists even as the economy is picking up, and it continued to trim monthly asset purchases that have pumped up its balance sheet to a record $4.41 trillion.

“A range of labor-market indicators suggests that there remains significant underutilization of labor resources,” the Federal Open Market Committee said today in a statement in Washington. “The likelihood of inflation running persistently below 2 percent has diminished somewhat.”

Policy makers tapered monthly bond buying to $25 billion in their sixth consecutive $10-billion cut, staying on pace to end the purchase program in October.

Fed officials led by Chair Janet Yellen are stepping up a debate over when to raise interest rates for the first time since 2006 as unemployment falls faster than expected and inflation picks up toward their 2 percent goal.

The outlook brightened today with a government report showing the economy expanded more than forecast in the second quarter. At the same time, Yellen has expressed concern about persistent signs of labor-market slack, including low wages. The FOMC repeated it’s likely to reduce bond buying in “further measured steps” and to keep interest rates low for a “considerable time” after ending purchases.

Committee’s Objective

“Inflation has moved somewhat closer to the committee’s longer-run objective,” the Fed said. Its preferred inflation gauge -- the personal consumption expenditure price index -- rose 1.8 percent in May from a year earlier. Its 12-month gain was as low as 0.8 percent in February.

“They are protecting their credibility” by flagging less risk that inflation will persist below their target, said Mark Vitner, senior economist at Wells Fargo Securities LLC in Charlotte, North Carolina. “Inflation has moved from a reason for the Fed to be easier for longer to more of a neutral factor in policy.”

Stocks gained while bonds remained lower after release of the Fed announcement. The Standard & Poor’s 500 Index increased 0.1 percent to 1,971.75 at 2:38 p.m., while the yield on the 10- year Treasury note rose nine basis points to 2.55 percent.

Philadelphia Fed President Charles Plosser dissented, objecting that the guidance on the timing of a rate increase was “time dependent” and didn’t reflect “considerable economic progress.”

Bond purchases will be divided between $15 billion in Treasuries and $10 billion in mortgage-backed securities.

Achieving Goals

Since meeting in mid-June, the committee has come closer to achieving its goals for stable prices and full employment. Employers added 288,000 jobs last month, helping push down unemployment to 6.1 percent, the lowest in almost six years.

Today’s Commerce Department report showed gross domestic product expanded at a 4 percent annual pace in the second quarter, confirming the Fed’s view that a first-quarter contraction was transitory.

Consumers, whose spending accounts for 70 percent of the economy, have grown more confident as the labor market improves and rising share prices boost wealth.

The S&P 500 index is up more than 6 percent this year after jumping almost 30 percent last year, aided by easy monetary policy and rising corporate profits.

Almost 77 percent of companies in the S&P 500 have posted second-quarter results that exceeded analysts’ estimates, according to data compiled by Bloomberg.

Slow, Steady

The recovery in demand has “been slow and steady,” said Mike DeWalt, corporate controller for Peoria, Illinois-based Caterpillar Inc., the world’s biggest maker of construction and mining equipment.

Yellen told lawmakers this month that while her view of the economy has turned “more positive,” she’s concerned about signs of job-market “slack” such as low participation in the labor force.

“We need to be careful to make sure that the economy is on a solid trajectory before we consider raising interest rates,” she said in her semi-annual testimony. “There are mixed signals.”

Among them: average hourly earnings fell or were stagnant in the past four months, after adjusting for inflation.

“The most important thing is to look at what’s going on with hourly wages,” according to Brian Jacobsen, who helps oversee $232 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin.

Flat earnings will probably compel policy makers to err on the side of keeping rates low, said Ellen Zentner, a senior economist at Morgan Stanley in New York.

“This is a Fed that’s going to have to be slapped across the face with higher wage growth before they raise interest rates,” she said in a July 25 Bloomberg Radio interview. “And we just haven’t seen any kind of data that points to that yet.”

--With assistance from Tom Keene in New York.

Copyright 2014 Bloomberg. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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