Fed Holds Policy Steady, Sees Unemployment Falling Faster Than Initially Expected

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Published March 20, 2013

| FOXBusiness

The Federal Reserve decided on Wednesday to hold interest rates at their historic lows and to maintain $85 billion in monthly bond-buying stimulus despite a more optimistic labor forecast from the central bank.

While the Federal Open Market Committee upgraded its unemployment rate outlook for the next three years, the Fed’s monetary policy arm dimmed its growth guidance slightly.

During a press conference following the FOMC decision, Fed chief Ben Bernanke largely shrugged off concerns about a possible bubble in the stock market and said he sees little "direct implications" for the U.S. economy from the deepening financial crisis in Cyprus. 

Voting 11-1 in favor of the interest rate decision, the Fed said new information received since the last meeting in January suggests “a return to moderate economic growth following a pause late last year,” but noted that “fiscal policy has become somewhat more restrictive.”

Alluding to February’s stronger-than-expected jobs report, the FOMC said “conditions have shown signs of improvement in recent months.” However, the central bank said the unemployment rate, which dipped to 7.7% in February, “remains elevated.”

Unemployment Outlook Raised

Still, the Fed’s new economic forecast reveals the central bank believes the unemployment rate will fall faster than previously expected.

It now forecasts a range of 7.3% to 7.5% for this year, compared with 7.4% to 7.7% back in December. Economists at the Fed see unemployment of 6.7% to 7% in 2014, down from 6.8% to 7.3% late last year.

The upper range of the 2015 estimate was also lowered by 0.1 percentage point to 6.5%, which is the target rate set by the Fed.

Michael Gapen, director of U.S. economic research at Barclays, said he doesn't interpret this new forecast "as a policy signal," rather as a "mark-to-market adjustment" following the decline in February.

On the other, the Fed trimmed its gross domestic product projections, forecasting 2.3% to 2.8% growth in 2013, down from 2.3% to 3% previously. Likewise, the Fed now sees GDP growth of 2.9% to 3.4% next year, down slightly from 3% to 3.5% earlier.

The Fed said that aside from energy price fluctuations, inflation has been running somewhat below the FOMC’s longer-term objective.

In an effort to continue to support the recovery, the Fed said it will continue purchasing $40 billion of mortgage-backed securities per month as well as $45 billion of Treasury securities a month, injecting $85 billion of liquidity into the sluggish economy.

Barclays said it sees "nothing" in the FOMC statement to change its view that the Fed will continue its pace of asset purchases through the end of 2013 before slowing them in the first half of next year. 

Worried About an Asset Bubble?

That could be good news for equity investors as the Fed’s unprecedented quantitative easing program has underpinned the rally on Wall Street.

The Dow Industrials hit fresh all-time highs on Wednesday afternoon following the FOMC decision.

Hinting at concerns about the Fed’s QE program doing more harm than good by inflating asset prices, the FOMC said it will continue to “take appropriate account of the likely efficacy and costs of such purposes as well as the extent of progress towards its economic objectives.”

During a press conference following the decision, Bernanke said the FOMC has had a “thorough discussion of costs and risks” of the QE program, including the impact of payments to the Treasury Department and risks to “financial stability” as investors take on “excessive risk in a reach for yield.”

However, Bernanke said the committee believes these costs “remain manageable.”

Asked if the Fed is worried about inflating an asset bubble, Bernanke said “in the stock market we don’t see at this point anything that’s out of line with historical patterns,” noting “increased optimism” about the economy and “substantial” corporate profit growth. 

He noted that while the Dow may be hitting new highs, “it’s in nominal terms, not in real terms” and still remains “some distance” from inflation-adjusted highs.

The FOMC said it expects to maintain a “highly accommodative stance of monetary policy” for a “considerable time” even after QE ends.

Despite the rosier unemployment rate, analysts said the FOMC statement indicates interest rates likely won’t be increased until 2015.

Shrugs Off Cyprus Concerns

Bernanke also addressed the ongoing turmoil in Cyprus, which is teetering on the brink of failure after rejecting a bailout that would have imposed a levy on bank deposits.

While he acknowledged that the tiny island nation is facing a “pretty big financial hole,” Bernanke said imposing a levy on bank deposits threatens to set a “precedent that might reduce confidence in banks in subsequent periods.”

Bernanke believes it's "extremely unlikely" such a similar tax on deposits could take place in the U.S., noting that the FDIC has never "lost a dime of insured deposits."

Overall, the Fed chief doesn't see Cyprus having "direct implications for the U.S. economy," pointing to the rally in the U.S. market despite the bailout rejection. 

"We hope the Europeans will come up with an efficient solution. We’re not seeing major risk to the U.S. financial system or the U.S. economy," he said.

Bernanke declined to give any new information about whether he plans to seek a third term as Fed chief when his term expires in January, but did say he had spoken to President Obama about his future,

Pointing to the competency of the Fed staff, Bernanke said: “I don’t think I’m the only person in the world who can manage the exit.”

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