Improving labor markets are bringing Federal Reserve officials closer to a time when they can get back to traditional central banking, where there’s a tighter connection between changes in economic data and movements in short-term interest rates.
The Federal Open Market Committee last month debated how much slack remains in labor markets, and came closer to an agreement on how to exit from the most aggressive stimulus in the Fed’s 100-year history, minutes from the July meeting showed.
Some participants “were increasingly uncomfortable” with the committee’s forward guidance on keeping its benchmark rate low for a “considerable time,” according to the minutes published yesterday. “Many” participants said they might have to raise borrowing costs sooner than they had anticipated.
“What runs through these minutes is that the FOMC is willing to adjust policy in response to the data, and investors need to be able to adjust as well,” John Bellows, a fund manager who helps oversee $75 billion at Western Asset Management Co. in Pasadena, California, said in an interview.
In the minutes, Fed officials “noted that if convergence toward the committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated.”
Fed Chair Janet Yellen will provide her take on the latest data on labor markets in a keynote speech tomorrow at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming.
Bellows contrasted today’s environment with that under Yellen’s predecessor, Ben S. Bernanke, who in September 2012 told markets that exceptionally low levels for the benchmark lending rate would still be warranted more than two years into the future.
Now, U.S. central bankers see enough progress in the job market that they can finally let go of their zero-rate policy sometime next year, said Michael Gapen, senior U.S. economist at Barclays Capital Inc., who helped Fed officials formulate their emergency policies when he was section chief at the Fed board from 2008 to 2010.
“They were so far from their goals that they were basically data independent” since 2008, the year policy makers cut rates close to zero, said Gapen. Now, as the Fed gets closer to its objective of maximum employment, the latest pieces of incoming data become more important for both policy makers and financial markets, Gapen said.
Stocks resumed their advance after declining following the release of the minutes. The Standard and Poor’s 500 Index added 0.3 percent to 1,986.51 at 4 p.m. in New York. The yield on the 10-year Treasury note was up three basis points, or 0.03 percentage point, to 2.43 percent.
Yellen has in speeches and congressional testimony focused on reducing slack in labor markets. She measures that with an array of indicators -- such as the share of unemployed who have been out of work for 27 weeks or more -- not solely on the unemployment rate, which stood at 6.2 percent last month, down from 6.7 percent at the end of 2013.
The jobless rate is still as much as a percentage point higher than Fed officials’ estimate of full employment. Both the FOMC statement last month, and the minutes released yesterday, emphasized there is still a “gap” between current labor-market conditions and “normal levels of labor utilization.” There are also signs of progress. Non-farm payrolls have increased at an average monthly rate of 230,000 this year, compared with 162,000 in the 2004-2007 pre-recession period.
In her Jackson Hole speech, Yellen could, as the minutes did, stress job-market progress. Or she could continue to point to the slack shown on her dashboard of labor-market data, which show the long-term unemployed, those out of work for 27 weeks or longer, represent 33 percent of the jobless, above the 19 percent average of 2004 to 2007.
Michael Feroli, chief U.S. economist at JPMorgan Chase & Co., said the Fed chair will probably be slightly more dovish than the committee consensus shown in the minutes.
“The committee is going where the data is going, and that is the way it should be,” said Feroli. “She is probably a bit more cautious than they are about the costs of raising rates too soon.”
Fed officials, discussing their strategy for eventual “normalization” of policy, expressed a desire to keep the federal funds rate as the key policy rate, targeting a range of 25 basis points “at the time of liftoff and for some time thereafter,” according to the minutes.
They would use the rate of interest on excess reserves as the “primary tool used to move the federal funds rate into its target range” while “temporary use” of its reverse repurchase facility, which it uses to borrow cash overnight from money-market mutual funds and others, would help set the floor.
There was no discussion of the timing of a rate increase in the minutes. Fed officials have forecast that it would occur some time next year.
The FOMC in July continued cutting the monthly pace of asset purchases, reducing it by $10 billion for a sixth straight meeting, to $25 billion. Bond buying has boosted the central bank’s balance sheet to a record $4.43 trillion.
Weak wage growth and low inflation have been providing the Fed room to keep interest rates near zero to bolster further progress in the labor market. Average hourly earnings rose 2 percent in July from the year before, matching the mean increase over the past five years and down from 3.1 percent in the year ended December 2007, Labor Department data showed in the latest employment report.
In their statement following the July decision, Fed officials said that “economic activity rebounded in the second quarter” and “the likelihood of inflation running persistently below 2 percent,” the Fed’s target for price increases, “has diminished somewhat.”
The Fed’s preferred inflation gauge, the personal consumption expenditures index, rose 1.6 percent in June from a year earlier. The increase was just 1 percent in February.
Another measure, the consumer price index, rose 2 percent in July from a year earlier, following a 2.1 percent advance the prior month.