Fed to Change Rate Guidance as Unemployment Falls, Minutes Show

Photographer: Andrew Harrer/Bloomberg

The Board of Governors of the Federal Reserve seal is seen outside the board room in Washington, D.C. Close

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Photographer: Andrew Harrer/Bloomberg

The Board of Governors of the Federal Reserve seal is seen outside the board room in Washington, D.C.

Federal Reserve policy makers backed away from their year-old commitment to consider raising interest rates when unemployment falls below 6.5 percent.

With joblessness falling faster than expected even as other labor-market indicators show weakness, policy makers agreed it would “soon be appropriate” to revise their guidance about how long the era of record-low interest rates will remain, minutes of their January meeting showed.

Several policy makers also said that in “the absence of an appreciable change in the economic outlook, there should be a clear presumption in favor” of continuing to trim the Fed’s bond purchases by $10 billion at each meeting.

Related: Yellen Says Recovery in Labor Market Far From Complete

Central bankers are seeking to provide clarity on their plans for continuing to support the economy, both with low interest rates and dwindling bond purchases, after unemployment dropped last month to 6.6 percent, the lowest in more than five years.

“It seems pretty safe to say that they are close to doing away formally with the 6.5 percent threshold, and given their concerns about inflation, rate hikes are unlikely any time soon,” said Dan Greenhaus, chief strategist for BTIG LLC in New York.

Stocks remained lower after the report, with the Standard & Poor’s 500 Index declining 0.7 percent to 1,828.75 at the close of trading in New York. The yield on the 10-year Treasury note rose two basis points, or 0.02 percentage point, to 2.73 percent.

While the minutes of the Federal Open Market Committee showed agreement on the need to change the unemployment threshold, officials were divided on how to clarify their guidance.

‘Existing Thresholds’

Some officials favored keeping some form of quantitative guidance, “while others preferred a qualitative approach that would provide additional information regarding the factors that would guide the Committee’s policy decision,” the minutes said.

The Fed's Taper

St. Louis Fed President James Bullard said today he would favor discarding the numerical threshold entirely.

“My preference would be, as we go through the threshold on unemployment, to just drop reference to these explicit thresholds and go back to a more normal policy,” Bullard, who doesn’t vote on policy this year, told reporters in Washington.

Instead, the central bank should “say that we’re looking at all the data on labor markets and inflation and we’re going to make a judgment about when the appropriate time to raise the policy rate would be,” Bullard said.

Forward Guidance

Related: Yellen Leads Fed Damned Every Which Way by Emerging Market Angst

The unemployment threshold is a form of forward guidance intended to help keep policy easy by assuring investors that rates will stay low until the economy improves.

In December 2012, the FOMC said it would hold the target interest rate near zero at least as long as unemployment remained above 6.5 percent, so long as forecasts for inflation do not climb above 2.5 percent.

Yet joblessness has fallen faster than Fed officials expected, in part because people have been dropping out of the labor force. When they first announced the threshold, most policy makers projected unemployment of 6.8 percent to 7.3 percent at the end of this year.

Last December, the committee strengthened its commitment, saying it would probably hold the rate near zero “well past the time” that unemployment falls below 6.5 percent. Since then, policy makers have started to back away from the threshold, saying that the jobless rate alone isn’t an adequate measure of labor-market health.

Broad Range

Fed Chair Janet Yellen, in congressional testimony this month, said policy makers “would be looking at a broad range of data on the labor market, including unemployment, job creation and many other indicators of labor market performance.”

The minutes show that the FOMC debated “the reliability of the unemployment rate as an indicator of overall labor market conditions.”

Several members said that broader measures of unemployment indicated “considerable labor-market slack.” One measure, which includes people who have stopped looking for work but wish they had a job, stood at 8.1 percent in January. Another, which includes part-time workers who want full-time employment, was 12.7 percent.

Several participants in January’s meeting also said that risks to financial stability should be included in their statement, and others argued the guidance should “give greater emphasis” to keeping rates low if inflation remains “persistently” below 2 percent.

“A few” officials “raised the possibility that it might be appropriate to increase the federal funds rate relatively soon,” according to the minutes.

‘Measured’ Cuts

The committee showed more consensus over how to proceed with reducing bond purchases. Since succeeding Bernanke on Feb. 3, Yellen has pledged to maintain his plan for “measured” cuts in purchases, even amid weaker-than-forecast payroll growth and signs harsh winter weather has slowed retailing, manufacturing and home construction.

“It all just points to the Fed tapering in March absent some proof that the economy has weakened substantially,” said Drew Matus, an economist at UBS Securities LLC in New York. “Nothing in the minutes suggests that they are not going to.”

Policy makers in January reduced purchases to $65 billion a month in the second consecutive $10 billion cut. Yellen, speaking in congressional testimony on Feb. 11, said only a “notable change in the outlook” for the economy would prompt a slower pace of tapering.

Low Inflation

The minutes show “a couple” of participants were concerned about low inflation and slack in the labor market and said the data “raised questions about the desirability of reducing the pace of purchases; these participants judged, however, that a pause in the reduction of purchases was not justified at this stage.”

Fed officials raised concerns about too-low inflation several times throughout their meeting. The personal consumption expenditures price index rose 1.1 percent last year, almost a full point below the Fed’s 2 percent goal.

Some participants wanted an “explicit indication” in their annual statement on policy goals that prices persistently above or below their 2 percent inflation target would be “equally undesirable.”

“I don’t recall another set of recent minutes being as concerned about inflation from the downside,” Greenhaus said.

The language on the policy goals statement will be reviewed this year. “Several” participants argued that the FOMC’s forward guidance in the statement “should give greater emphasis to the committee’s willingness to keep rates low if inflation were to remain persistently below” the 2 percent target.

The Fed met before a government report showed payrolls increased by 113,000 in January, less than economists forecast, after a gain of 75,000 in December. She same report showed the jobless rate unexpectedly declined to 6.6 percent.

To contact the reporters on this story: Joshua Zumbrun in Washington at jzumbrun@bloomberg.net; Jeff Kearns in Washington at jkearns3@bloomberg.net

To contact the editor responsible for this story: Chris Wellisz at cwellisz@bloomberg.net

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