The Fed Still Wants Easy Money

Janet Yellen, chair of the U.S. Federal Reserve.

Janet Yellen, chair of the U.S. Federal Reserve.

Photographer: Andrew Harrer/Bloomberg

Janet Yellen wants you to know that while the era of zero rates may be drawing to a close, money will stay cheap for a long time to come.

The Federal Reserve chair and her colleagues have stressed in recent speeches that monetary policy will remain unusually easy after they begin to tighten this year for the first time in almost a decade. They are telling investors that the pace of increases is more important than the liftoff date.

“This should be the slowest tightening cycle since the funds rate became the policy instrument of choice” in 1982, said Roberto Perli, a former Fed official who is now a partner at Cornerstone Macro LLC in Washington.

Policy makers have ruled out an increase at the next meeting of the Federal Open Market Committee, April 28-29. New York Fed President William C. Dudley stressed on Monday that once they start to lift rates above zero, “we will simply be moving from an extremely accommodative monetary policy to one that is only slightly less so.”

While they have left the door open for a move in June, officials including Atlanta Fed President Dennis Lockhart have indicated a preference for patience amid signs of slowing first-quarter growth.

“I would lean to a little later versus a little earlier,” Lockhart, who votes on policy this year and is seen as being close to the consensus on the FOMC, told reporters after giving a speech in West Palm Beach, Florida last week.

September Liftoff

The proportion of economists predicting the Fed will wait until September to raise rates rose to 70 percent in an April 3-9 survey from 32 percent last month.

While some officials express optimism that growth will pick up again after the impact of a stronger dollar and harsh winter weather wear off, the economy will still be hobbled by “structural damage” done by the Great Recession, said Cleveland Fed President Loretta Mester.

“A gradual path is justified because there continues to be uncertainty about long-run growth rates,” Mester said in an interview last week.

Officials in March predicted the funds rate would be 1.875 percent by the end of the 2016 and 3.125 percent by the end of 2017. Investor expectations for the rate path are even lower. According to euro dollar interest rate futures, rates will have barely moved above 1 percent by the end of 2016 and will still be under 2 percent 12 months later.

That mismatch may reflect the pessimism of investors and spillovers from even lower borrowing costs in Europe.

Economic Spirits

For policy makers, the goal is to tighten without damping the economy’s spirits too much, according to Richmond Fed President Jeffrey Lacker.

Lacker, in a recent speech, reached for a metaphor made famous by former Fed Chairman William McChesney Martin, who said the Fed’s job is to take the punch bowl away before the party gets started.

“Raising the funds rate target a notch or two is less like taking away the punch bowl and more like just slowing down the refills,” Lacker said in a Sarasota, Florida.

Another reason for the caution: policy makers don’t know how the economy will react to the first rate increases since 2006, and they worry premature tightening could cause growth to falter, forcing them to cut borrowing costs back to zero.

Before they make a move, officials have said they want to see further improvement in the labor market and be “reasonably confident” that inflation will move back up toward their goal.

Jobs, Inflation

At 5.5 percent, unemployment is still above the long-run rate of 5 percent to 5.2 percent projected by Fed officials. And inflation has lingered below their 2 percent target for 34 months, according to the central bank’s preferred measure.

Signaling a 2015 rise has helped Yellen forge unanimous support for her exit plan, appeasing FOMC members who, like Lacker, worry that keeping rates too low for too long risks spurring asset price bubbles.

At the same time, she’s setting up for a “glacial pace of tightening thereafter,” favored by committee members who worry about weak employment, said Jonathan Wright, a professor at Johns Hopkins University in Baltimore and a former economist at the Fed’s Division of Monetary Affairs.

“Yellen and others on the FOMC are trying to keep overall financial conditions accommodative even as liftoff comes closer,” Wright said.

Data Dependent

The Fed also wants to avoid a steady and predictable series of increases, emphasizing instead that decisions will be taken meeting-to-meeting, based on the latest data.

“Policy tightening could speed up, slow down, pause, or even reverse course depending on actual and expected developments in real activity and inflation,” Yellen said at a March 27 conference in San Francisco.

That would be a contrast to the 2004-2006 cycle, when the Fed under Alan Greenspan raised rates in quarter-point increments at every meeting and announced it expected to remove accommodation “at a pace that is likely to be measured.”

FOMC members may be emphasizing the gradual pace to prevent a sharp market reaction to the first increase, said Michael Feroli, JPMorgan Chase & Co. chief U.S. economist in New York. At the same time, he said, they’re trying to avoid creating too much certainty on the schedule.

Financial Imbalances

“There is a lingering sense that the steady rate hikes that you saw in 2004 and 2006 contributed to the financial imbalances that built up, because the Fed was so predictable that people could rely on it, but that ends up coming at the cost of increased leverage,” said Feroli, a former Fed economist.

Now, investors and economists will have to work harder to predict the future direction of policy as data -- rather than schedules -- drive Fed decisions.

“The training wheels are coming off, to some extent, on monetary policy,” said Scott Anderson, chief economist at Bank of the West in San Francisco. “Economic data, it’s going to get a lot closer scrutiny.”

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