The U.S. Federal Reserve now expects to leave its key interest rate near zero through at least the end of 2014, an extraordinary signal meant to coax wary companies, consumers and investors off the sidelines by assuring them of ultra-low borrowing costs for a long time yet.
For the first time Wednesday, the U.S. central bank released the interest rate projections of each of the 17 officials who influence policy, extending its timeline for a hike by more than a year. Bond yields tumbled and stock markets rose. The Canadian dollar also strengthened as traders bet the Bank of Canada would raise borrowing costs ahead of the Fed, a prospect that would make Canadian interest-bearing assets relatively more attractive.
The overall message from the Fed was fairly straightforward: The U.S. central bank is skeptical that a slew of positive indicators herald the kind of economic growth that would meaningfully lower an elevated unemployment rate.
After two days of deliberations in Washington, five members of the Fed’s policy-making committee decided that the benchmark federal funds rate should remain at its current setting of between zero and 0.25 per cent until the end of 2014, while four said the target should be left unchanged until 2015. Two participants think the U.S. economy is so weak that rates will need to stay low until 2016.
The Fed didn’t stop there. It released new forecasts that predict weaker economic growth this year, an unemployment rate as high as 8.1 per cent in 2013 and muted inflation pressures. The Fed also stated explicitly that it will attempt to keep prices advancing at an annual rate of about 2 per cent, another first.
As a result, the Fed remains poised to do whatever it can to push the economy along. Providing more information about its thinking is part of that effort, but policy makers are ready to do even more, including another round of bond buying with newly created money, a monetary strategy known as quantitative easing.
“I don’t think we are ready to declare that we’ve entered a new, stronger phase at this point,” chairman Ben Bernanke said at a press conference.
Quantitative easing is “an option that certainly is on the table,” Mr. Bernanke added. “It would be premature definitively to say one way or the other, but we continue to look at that option. If conditions warrant, we will certainly consider using it.”
It was a historic day for the Fed. The disclosure of interest rate projections immediately transformed a notoriously opaque institution into one of the most transparent central banks in the world.
Fed officials will refresh their interest rate forecasts every quarter, along with their outlooks for economic growth, unemployment and inflation. That will allow the public to observe changes in the consensus of opinions at the Fed and adjust its own investing decisions accordingly.
Some economists predicted a bumpy ride as traders figured out what to make of a raft of new data. The first jolt came when the Fed announced that the majority of officials felt that the benchmark mark interest rate would have to stay at zero until at least late 2014 in order to stoke enough economic growth to lower the unemployment rate from its current 8.5 per cent. The commitment did away with previous guidance that borrowing costs would need to remain low only through to the middle of 2013.
The Dow Jones industrial average rose 0.6 per cent to its highest level since May, and the yield on five-year Treasury notes touched a record low of 0.8 per cent. The Canadian dollar reversed earlier losses against its U.S. counterpart, jumping to 99.6 U.S. cents, the strongest since November. Canada's benchmark interest rate is 1 per cent.
“Clearly, the Fed will do whatever it takes to reboot the economy,” Bank of Montreal chief economist Sherry Cooper said in a note to clients.
The Fed’s interest rate guidance is less than a promise. Mr. Bernanke told reporters that there is no “mechanical” link between officials’ projections and policy decisions. Changes in economic circumstances will bring about regular revisions in the forecasts.
For now, 11 of 17 participants at this week’s policy-making committee meeting think the benchmark interest rate will need to stay at zero until the end of next year, and a similar number foresee a federal funds rate of 1 per cent or less at the end of 2014.
The reason so many at the Fed favour a loose policy is because they project weak economic growth and mild inflation. The consensus growth outlook is 2.2 to 2.7 per cent in 2012, a downgrade from 2.5 to 2.9 per cent in November. The Fed in a statement characterized U.S. economic growth as “modest.”
Modest growth won’t put great numbers of Americans back to work. The Fed has a mandate to not only restrain inflation, but create the conditions for maximum employment. The Fed shied away from setting a target for the unemployment rate, saying there are too many factors that determine hiring.
However, the central bank said in a statement that the committee’s longer-run consensus for the unemployment rate is a decent guide for what policy makers are trying to achieve. That consensus currently is 5.2 to 6 per cent, considerably lower than the current unemployment rate.
“Clearly at 8.5 per cent we are comfortably above anybody’s estimate” of the natural rate of unemployment, Mr. Bernanke said.
THE FED’S VIEWS, THEN AND NOW
December: The Fed “anticipates that economic conditions ... are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”
January: This is the most newsworthy change in the statement. The Fed “anticipates that economic conditions ... are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
Then: “Inflation has moderated since earlier in the year, and longer-term inflation expectations have remained stable.”
Now: The Fed sees prices in check and little threat of inflation, which gives it more room to keep the interest rate it controls at its current record-low level of nearly zero. “Inflation has been subdued in recent months, and longer-term inflation expectations have remained stable.” Fed policy makers also left off a sentence from previous statements that said they would “continue to pay close attention to the evolution of inflation and inflation expectations.”
Then: The Fed “continues to expect a moderate pace of economic growth over coming quarters.”
Now: The Fed's take on the economy hasn't changed much. It “expects economic growth over coming quarters to be modest.”