Fed offers a dual message on health of US economy

July 30, 2014

Washington (July 30)  The Federal Reserve offered a mixed message on the U.S. economy Wednesday: Growth is strengthening, and the unemployment rate is steadily falling. Yet by some measures, the job market remains subpar.

A statement the Fed issued after a two-day policy meeting suggested it wants to see further improvement before it starts raising its key short-term interest rate. It offered no clearer hint of when it will raise that rate.

Instead, the Fed reiterated its plan to keep short-term rates low "for a considerable time" after ends its monthly bond purchases. The Fed said it will slow the pace of its purchases by another $10 billion to $25 billion a month. The purchases, which have been intended to keep long-term borrowing rates low, are set to end in October.

Most economists think a rate increase is about a year away despite a strengthening economy. The government estimated Wednesday that the economy grew at a fast 4 percent annual rate last quarter.

On Friday, the government is expected to report a sixth straight month of healthy 200,000-plus job growth. The unemployment rate has dropped to 6.1 percent. At the start of last year, it was 7.9 percent.

The Fed revised the wording of its previous statement to note that while the unemployment rate has dropped steadily, the job market is still struggling in other ways. It didn't specify what it meant. But Chair Janet Yellen expressed concern to Congress this month about stagnant wage growth, many part-time workers who can't find full-time jobs and the proportion of the unemployed who have been out of work for more than six months.

The Fed also tweaked its statement to say inflation had risen closer to its 2 percent target. The statement said concerns that inflation would persistently run below the Fed's 2 percent target had "diminished somewhat." But it expressed no concerns about the slight acceleration in prices.

The Fed's action Wednesday was approved on a 9-1 vote, with Charles Plosser, president of the Fed's Philadelphia regional bank, dissenting. The statement said Plosser objected to reiterating that the Fed's key short-term rate would likely remain at a record low near zero "for a considerable time" after its bond purchases end.

Plosser felt that language did not "reflect the considerable economic progress that has been made," the statement said.

Economists said the Fed's statement showed that Yellen remains firmly in control of the policy committee even though Plosser and other officials who are more concerned about inflation are starting to express their views more openly. This group is known as hawks. Yellen's camp, which is more focused on maximizing employment, is known as doves.

Another hawk, Richard Fisher, president of the Fed's Dallas regional bank, wrote an opinion piece in the Wall Street Journal this week that suggested it was time for the Fed to start moving away from its ultra-low rate policies.

David Jones, chief economist at DMK Advisors, said a new phrase in the Fed statement about a "significant underutilization of labor resources" showed that Yellen's more dovish views held sway in the discussions.

"The Fed is continuing to express concern about labor markets and expressing no alarm about the rise in inflation," Jones said. "Yellen is still a dove at heart."

Though the statement set no specific date for the Fed's bond purchases to end, Yellen told Congress this month that they would likely end at the October meeting with a final $15 billion cut. That would imply a further $10 billion reduction at the Fed's next meeting in September.

In October, the Fed's investment portfolio will be nearing $4.5 trillion -- five times its size before the financial crisis erupted in September 2008.

After the crisis struck, the Fed embarked on bond purchases to try to drive down long-term rates and help the economy recover from the Great Recession. Even after its new bond purchases end, the Fed has said it will maintain its existing holdings, which means it will continue to put downward pressure on rates.

The Fed has kept its target for short-term rates near zero since December 2008. Many analysts said they saw nothing in Wednesday's statement to change their forecast that the first rate increase will occur no sooner than mid-2015. But some said that if the economy remains strong in coming months, the Fed will likely move forward its first rate increase to the first half of next year.

Besides discussing short-term rates, Fed officials likely debated how to unwind their investment holdings. They face a delicate task in shrinking the portfolio to more normal levels without destabilizing markets. The Fed's bond purchases allowed it to inject money into the financial system, which wound up as reserves held by banks and helped keep loan rates low.

To reverse that process and raise borrowing rates, the Fed is considering a variety of tools. One would be to increase the interest it pays banks on excess reserves they keep at the Fed. There was no mention of the exit strategy in Wednesday's statement, though Jones said a discussion of the issue will likely appear in the minutes of the meeting to be issued in three weeks.

Yellen told Congress that the Fed expects to provide more details on its exit strategy before the year is out.

Source: SeattleTimes

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