How Yellen-led Fed tweaks low-rate pledge is one key

File photo of Federal Reserve Vice Chair Janet Yellen addressing a conference in Washington

The Federal Reserve has said again and again that it wants to keep interest rates low for a long time. But it keeps fiddling with how to express that commitment.

Another shift in that communications strategy is set to occur when the central bank’s interest-rate-setting committee gathers for two days of talks on Tuesday and Wednesday, as it’s the first meeting to be led by Janet Yellen, the new chairwoman. The Fed will release a policy statement and updated economic forecasts at 2 p.m. Eastern on Wednesday, and Yellen will hold a press conference at the end of the deliberations at 2:30 p.m.

With the Fed and the markets basically on the same page on the economy, the current near-zero interest-rate policy, and the rate of reduction in bond purchases, the central bank has an opportunity to revamp its forward guidance tool, now the chief policy instrument.

“They’ve got a little room to unanchor these things,” said Lewis Alexander, chief economist at Nomura Holdings Inc. in New York.

So-called forward guidance attempts to drive down long-term rates by promising to keep short-term rates low for a long time.

The Fed has reworded its pledge throughout the financial crisis. Alexander said the early forms of forward guidance were simpler as the Fed was simply saying that it was a long way from raising rates.

The Fed’s current pledge is to hold rates steady until “well past” the point when the unemployment rate falls below 6.5%.

But the unemployment rate has steadily dropped over the past year, before ticking up slightly to 6.7% in February

“It is time to seriously rethink that 6.5% unemployment target because we are so close to it,” said former Fed governor Randall Kroszner

Yellen has signaled that she would be comfortable with this change, analysts said, when she told lawmakers last month that the unemployment rate did not fully summarize the health of the labor market.

Experts don’t think the Fed will simply lower the threshold to a 6% unemployment rate. Instead, the prevailing view is the Fed will move to a more “holistic” description of labor-market activity.

The new guidance is likely to be “be less specific and more ambiguous and point to a variety of indicators,” said Jeffrey Cleveland, chief economist at Payden & Rygel in Los Angeles.

It’s not the only item on the Fed’s agenda.

Another focus will be on the Fed’s growth, inflation and interest-rate forecasts.

“The words won’t matter much,” said Avery Shenfeld, chief economist at CIBC World Markets, in an interview. “The market will look at the Fed’s projections.”

The market now expects the fed funds rate to be 0.6% by the end of 2015, implying one rate hike. This is close to the Fed’s own projection, Alexander said.

Economists expect the Fed’s forward guidance to be tested once the weather impact clears. Yellen told the Senate Banking Committee late last month that it is “difficult to discern exactly how much” bad weather was obscuring the economic outlook.

If the economy snaps back in the second quarter, market participants will likely pull forward the anticipated date of the first policy tightening into earlier in 2015, Alexander said.

“There is no doubt the market will test the Fed,” said Robin.

Payden & Rygel’s Cleveland said that if markets started to price in an earlier tightening, the Fed might be forced to be more specific with its guidance. The timing of the first rate hike in mid-2015 appears to be the “line in the sand,” he said. So, for the time being, he said, the Fed “can use words.”

As for the Fed’s bond-purchase program, it’s barely in the spotlight after dominating the agenda for so much of last year.

Despite generally weak data since its last meeting in January, the central bank is widely expected to continue to reduce the pace of its monthly asset purchases by a further $10 billion, to a rate of $55 billion a month.

“Tapering is clearly on tap,” said Alexander.

This would be the third straight Fed policy meeting with a gradual reduction in the pace of purchases. Analysts expect the slow reduction to continue until the program is fully wound down, at the end of the third quarter. Only a shock to the economy would cause the Fed to change course, analysts said.

This article wrote by Fxstay for www.topforexbrokers.com

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