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Get ready for a new rate-hiking threshold

The U.S. Senate Banking Committee on Thursday approved Janet Yellen’s nomination to become the first woman to lead the Federal Reserve, sending it to the full Senate for a final vote.

Joshua Roberts/Reuters

Move over, Crimea. The Federal Reserve is set to release its policy statement this week, which is going to redirect investor attention away from geopolitical issues and back to monetary ones.

Most economists believe that tapering – now two months in the works – will continue, barring any significant setback in the economic recovery. But the key this month is going to be how the Fed adjusts its forward guidance on policy. In recent statements, the Fed has gone out of its way to assure markets that there is no economic number that will force the Fed to switch into a rate-raising mode.

The last statement, released at the end of January, said that "it likely will be appropriate to maintain the current target range for the federal funds rate well past the time that the unemployment rate declines below 6.5 per cent, especially if projected inflation continues to run below the Committee's 2 per cent longer-run goal."

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But as Ed Yardeni of Yardeni Research pointed out, the minutes from the last Fed meeting suggested that some language alterations were in the works now that the unemployment rate is approaching the 6.5 per cent threshold. The minutes then outlined five views: lower the unemployment rate threshold; take a qualitative approach to thresholds; emphasize financial stability as a key factor; give more weight to the inflation target; or just get ready to raise rates.

"In my opinion, the FOMC is likely to devise some new data-dependent rule to justify continuing NZIRP (near zero interest rate policy)," Mr. Yardeni said in a note. "They might lower the unemployment rate threshold to 5.5 per cent and stress that inflation must rebound back to 2 per cent before they'll even consider raising rates."

Fed policy has been hanging over the stock market since 2013, when markets initially reacted with some concern over the Fed's plan to taper its bond-buying stimulus program, known as quantitative easing. If the Fed now lowers its threshold for raising rates, yet another layer of concern will be removed.

That should be good for stocks in the near term. But as any cautious investor will tell you, Fed-driven rallies also raise anxiety over what happens when the Fed finally signals that the easy-money policies that have defined the entire bull market finally come to an end.

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