Yellen Assertion of No Rate Change Doubted as Yields Rise
In her first press conference as Fed chair yesterday, Yellen emphasized that dropping a 6.5 percent unemployment threshold for considering an interest-rate increase “does not indicate any change in the committee’s policy intentions.”
Rather than paying heed to Yellen’s assertion, investors seized on an increase in Fed officials’ own interest-rate forecasts and Yellen’s comment that borrowing costs could start rising “around six months” after it stops buying bonds. Yields on two-year Treasury notes climbed as much as 10 basis points yesterday, the most since June 2011.
The market reaction highlights the perils faced by central bankers when they retreat to language investors consider vague after setting precise numerical markers for changes in policy. Lacking specific guidance in the Fed’s policy statement, investors swung toward the next best thing: Fed officials’ own forecasts for the benchmark federal funds rate.
“With the shift to qualitative guidance, the only quantitative metric we have is the fed funds projections from the Fed,” said Dean Maki, chief U.S. economist for Barclays Plc in New York and formerly an economist at the central bank. “So while the statement and Chair Yellen in the press conference said little had changed, the Fed’s projections suggested that there was a notable change in the Fed’s outlook.”
Treasuries were little changed today, with the yield on the two-year note at 0.42 percent at 4:34 p.m. in New York and the yield on the benchmark 10-year note at 2.77 percent. The spread between yields on the two-year note and the 30-year bond, known as the yield curve, narrowed to 324 basis points today, the least on a closing basis since Feb. 3.
The Federal Open Market Committee said it will no longer link borrowing costs to a specific unemployment rate, saying it would instead consider a broad range of indicators on the labor market, inflation and financial markets.
“We know we’re not close to full employment, not close to an employment level consistent with our mandate, and unless inflation were a significant concern, we wouldn’t dream of raising the federal funds rate target,” Yellen said at the press conference in Washington.
Separately, the Fed released new forecasts showing more officials predicting the benchmark rate, now close to zero, would rise at least to 1 percent at the end of 2015 and 2.25 percent by the end of the following year, higher than previously forecast. Those numbers are based on the median forecast of 16 Fed officials.
This month, 10 policy makers estimated the benchmark lending rate would be 1 percent or higher at the end of 2015, up from seven in December. Twelve policy makers forecast the rate would be 2 percent or higher at the end of 2016, up from eight. The total number of forecasts fell to 16 this month from 17 in December.
Yellen downplayed the quarterly forecasts, which are displayed as a series of dots on a chart.
“One should not look to the dot-plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large,” she said, adding that the FOMC statement should take precedence over the forecasts.
“She really tried to talk it down,” said Michael Hanson, senior U.S. economist at Bank of America Corp. in New York and a former Fed economist. “So I think the markets left saying, ‘Well wait a second, what are we supposed to listen to?’”
Stock benchmarks extended declines after Yellen, responding to a question, indicated that the federal funds rate might start to rise about six months after the central bank ends its bond-purchase program.
The FOMC statement repeated that the rate will stay low for a “considerable time” after asset purchases end. Asked how long that might be, Yellen said: “you know, this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing.”
She added that “it depends on what conditions are like,” and that if inflation “is persistently running below our 2 percent” goal, that would be “very good reason to hold the funds rate at its present range for longer.”
Inflation measured on a 12-month basis has been below the Fed’s 2 percent goal for almost two years, and prices rose just 1.2 percent for the year ending January. Still, financial markets ignored her caveat.
The Fed is overhauling its most specific guidance ever on the benchmark lending rate after unemployment declined toward 6.5 percent, its previous threshold for a rate increase, faster than policy makers predicted.
“The committee has never felt that the unemployment rate is a sufficient statistic for the labor market,” Yellen said at the press conference. “It’s appropriate to look at many more things, and that’s why the committee now states we will look at a broad range of information.”
The FOMC announced a $10 billion reduction in monthly bond-buying to $55 billion and repeated that it will taper purchases “in further measured steps at future meetings.” At the same time, “asset purchases are not on a preset course.” The committee announced $10 billion reductions in purchases at the previous two meetings.
“Growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions,” the Fed said. Even so, “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor-market conditions.”
Minneapolis Fed President Narayana Kocherlakota dissented, saying the statement “weakens the credibility of the committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.”
Yellen responded to the dissent in her press conference, saying the committee is “fully committed” to the 2 percent inflation target.
“We do not want to undershoot inflation for a prolonged period of time,” she said.
Seventy-six percent of economists in a Bloomberg survey March 14-17 predicted the Fed would drop its unemployment threshold. Economists also predicted a $10 billion reduction in the monthly pace of bond purchases, according to the median of responses.
Yellen, 67, took over as Fed chair last month after three years as deputy to Ben S. Bernanke. In that role, she helped shape the communications policies the Fed wielded as it sought to nurture a recovery from the worst recession since the Great Depression.
After cutting interest rates to zero in 2008, the Fed embarked on large-scale asset purchases as well as forward guidance intended to convince investors that borrowing costs would stay low for a long time.
Starting in December 2012, the FOMC said the federal funds rate would stay low at least as long as unemployment was higher than 6.5 percent and the outlook for inflation didn’t exceed 2.5 percent.
With the jobless rate at 6.7 percent last month, that guidance was fast becoming obsolete.
To contact the editors responsible for this story: Chris Wellisz at firstname.lastname@example.org James L Tyson