Fed Says Economy Rebounding as It Trims Bond Purchases

The Federal Reserve said growth is bouncing back and the job market is improving as it continued to reduce the monthly pace of asset purchases.

“Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace,” Fed Chair Janet Yellen said at a press conference in Washington today. Even with declines in unemployment, “a broader assessment of indicators suggests that underutilization in the labor market remains significant.”

The Federal Open Market Committee trimmed bond-buying by $10 billion for a fifth straight meeting, to $35 billion, keeping it on pace to end the program late this year. Stocks rallied, sending one of the broadest measures of global equities to an all-time high, as Yellen emphasized the need to put more Americans back to work and downplayed concerns about asset-price bubbles and incipient inflation.

“The Fed isn’t going to withdraw stimulus at the first sign of inflation running a little above their target,” said Brian Jacobsen, who helps oversee $242 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “Investors like that because the Fed’s going to stay accommodative.”

The MSCI All-Country World Index advanced 0.6 to a record 427.70 at 4 p.m. in New York. The Standard & Poor’s 500 Index jumped 0.8 percent for a fourth day of gains and a record close. Ten-year Treasury note yields fell six basis points, or 0.06 percentage point, to 2.59 percent.

‘Measured Steps’

Yellen repeated that the Fed is likely to “reduce the pace of asset purchases in further measured steps” and that it expects interest rates to stay low for a “considerable time” after the buying ends. She declined to offer a more specific timetable for the first interest-rate increase since 2006, saying there’s “no mechanical formula.”

Fed officials also released a new set of quarterly forecasts, predicting that the benchmark interest rate will rise more rapidly once officials decide to increase it above zero sometime next year.

Officials predicted the rate will be 1.13 percent at the end of 2015 and 2.5 percent a year later. In March, they predicted 1 percent at the end of next year and 2.25 percent in 2016.

As she has in the past, Yellen downplayed the significance of the interest-rate forecasts, which are displayed as dots on a chart.

“Around each of those dots, I think every participant who’s filling out that questionnaire has a considerable band of uncertainty around their own individual forecast,” she said.

Low Inflation

Yellen said inflation “has continued to run below the committee’s 2 percent objective,” and low inflation “could pose risks to economic performance.”

The personal consumption expenditures index, the Fed’s preferred inflation gauge, rose 1.6 percent from a year earlier in April, the most since November 2012. The consumer price index, a separate inflation measure, rose 2.1 percent in May.

Recent inflation data, while “noisy,” suggests that consumer prices “are moving back gradually over time toward our 2 percent objective,” she said.

Steady labor-market gains have bolstered confidence among policy makers that they can wind down asset-buying without endangering the five-year expansion.

Unemployment held at 6.3 percent in May, the lowest in almost six years, and payrolls increased by more than 200,000 for a fourth consecutive month, the first time that’s happened since early 2000.

‘Shadow Unemployment’

Still, Yellen said, “a portion of the decline we’ve seen in the unemployment rate probably reflects a kind of shadow unemployment or discouragement.”

The Fed has sought to spur growth and employment with three rounds of large-scale asset purchases intended to hold down long-term borrowing costs. The purchases have swelled the central bank’s balance sheet to a record $4.34 trillion.

Fed officials are testing tools that will be needed to tie up excess reserves in the banking system, a step they will have to take in order to raise short-term rates.

“The committee is confident it has the tools it needs to raise short-term interest rates” when necessary, Yellen said. The Fed “will continue to have a very large balance sheet for some time.”

Yellen said policy makers are discussing a new set of principles to guide an eventual exit from record easing and expects to announce them later this year.

Growth Outlook

Fed officials are counting on a faster expansion to pull more people back into the labor force. The pace of growth will exceed 3 percent in the final three quarters of the year, according to economists surveyed by Bloomberg, after a 1 percent first-quarter contraction caused in part by harsh winter weather.

Manufacturing grew in May at the fastest pace this year, according to data from the Institute for Supply Management. The ISM’s service-industry gauge showed the strongest expansion since August.

The quickening economy and better-than-estimated corporate earnings have pushed up U.S. stocks to new highs while reducing volatility in financial markets.

“The committee doesn’t try to gauge what is the right level of equity prices,” Yellen said today. Rather, it looks to see if valuation levels “are outside of historical norms. I still don’t see that broadly.”

The Chicago Board Options Exchange Volatility Index, a gauge of S&P 500 swings, fell to the lowest since early 2007. Foreign-exchange volatility also has slowed, falling to an almost seven-year low.

Low Volatility

Low financial-market volatility has stirred concern among some policy makers. New York Fed President William C. Dudley said last month it may signal investor complacency about risk, making him “a little nervous.”

The FOMC gained three new voting members for this meeting. The U.S. Senate voted last week to approve the nomination of Lael Brainard, former U.S. Treasury undersecretary for international affairs, as a governor. It also approved Stanley Fischer as vice chairman. Loretta Mester on June 1 succeeded Sandra Pianalto as president of the Cleveland Fed.

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