Fed Clarifies Cloudy Rate Hike Issue

Federal Reserve policy makers on Wednesday offered few surprises, maintaining their bond purchase tapering program and keeping interest rates at their historically low levels.

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What they did do was offer clarification to a situation that has become increasingly cloudy as the unemployment rate has dropped in recent months to its current level of 6.7%.

Although some analysts said the clarification only muddied the waters further.

Over a year ago the Fed established a 6.5% unemployment rate as a target for when the central bank would consider raising the fed funds rate, the short-term rate banks charge each other. At the start of 2013, the unemployment rate stood at 7.9%. Since then it has fallen more than a full percentage point -- but not always for the right reasons.

As the unemployment rate approached the threshold established by the Fed, markets have grown increasingly uneasy, wondering if the Fed would stick to that threshold or adjust its policy.

On Wednesday they got their answer, in writing: the Fed threw out that 6.5% unemployment threshold and said it would consider instead an array of economic indicators.

The move was widely expected -- and broadly telegraphed by policy makers.

Michael Block, chief strategist at Rhino Trading, noted ahead of the announcement that the Fed has already made clear in prior FOMC statements that it will use a basket of indicators to determine the timing for raising interest rates.

He pointed to the Jan. 29 statement, which read: “In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”

Wednesday’s statement said virtually the same thing: “In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the Committee will assess progress – both realized and expected – toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.”

In addition, in language similar to that used earlier by the FOMC and often reiterated by former chairman Ben Bernanke, the FOMC on Wednesday said interest rates would  remain at their current levels for “a considerable time” after the bond purchase program known as quantitative easing is phased out.

Block predicted that the Fed would be intentionally vague in establishing future thresholds.

“By keeping this basket as vague as possible, (Fed Chair Janet) Yellen and company create this imaginary ten foot high stuffed bunny rabbit that we are all looking for to determine when the Fed becomes hawkish … but it doesn’t necessarily exist,” he said.

Peter Boockvar, chief market analyst at the Lindsay Group, said the changes “are more logistics than anything.”

“This is what is now called ‘qualitative guidance’ and I now refer to it as ‘vague guidance’ and much less valuable than something more ‘quantitative’ that we can at least gauge,” Boockvar said in a note immediately following the statement’s release. “Policy is now even more subjective. Winging it is also another way of stating the direction of policy. Not helpful.”

The problem with the unemployment rate is that for much of 2013 it was falling because each month tens of thousands of people were leaving the workforce for various reasons, either because they were retiring or because they couldn’t find a job.

So the unemployment rate was falling because potential workers were leaving the workforce, not because thousands of people were finding jobs. The Fed was well aware of this dynamic but waited until Wednesday to fully clarify its position in an effort to remove uncertainty from the markets.

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