Fed Shifting Focus from Tapering to Interest Rates

The focus of Federal Reserve policy makers meeting this week has likely shifted away from tapering bond purchases toward the timing for eventually raising interest rates.

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Newly-elevated Fed Chair Janet Yellen will hold her first press conference after the policy setting Federal Open Market Committee (FOMC) statement is released at 2 p.m. Wednesday.

An announcement that the Fed will reduce its monthly bond purchases by another $10 billion is all but a done deal. With that issue resolved for the time being, FOMC members are expected to clarify their guidance on the future of interest rates.

“The course for ending bond purchases is firmly on track. The worst is behind us. The  unemployment rate continues to trend lower. A central bank has to think ahead,” said Jeremy Lawson, chief economist at Standard Life Investments in Scotland.

Despite mixed economic data throughout much of the first quarter, the Fed is widely expected  to announce it is reducing the total amount of bonds purchased each month to $55 billion.

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“The data recently have been mixed but neither weak enough nor strong enough to divert the Fed from its current tapering pace,” said David Kelly, chief global strategist at JPMorgan Funds.

The Fed first announced the start of its tapering program in December, when bond purchases stood at $85 billion per month. The Fed has said it hopes to gradually reduce bond purchases by about $10 billion per month, eventually phasing out the asset purchasing program altogether by the end of the year.

After months of mixed messages from Fed officials throughout much of 2013, mostly related to when the Fed should begin tapering, the members now appear to all be on the same page with regard to gradually ending the program.

Hawks such as Philadelphia Fed President Charles Plosser and doves such as Yellen are both on record as saying the economic data would have to shift dramatically for the central bank to swerve from its stated goal of gradually ending asset purchases, or quantitative easing.

So with that issue relatively settled policy makers the focus is expected to shift to interest rates.

Markets Looking for New Guidance on Interest Rates

Specifically, markets are hoping the Fed will provide new guidance on when it might consider raising the key fed funds interest rate -- the rate banks charge one another for short-term loans -- from the near-zero range where it’s held steady since December 2008 during the darkest days of the financial crisis.

More than a year ago the Fed established a 6.5% unemployment rate as a target for when the central bank would consider raising interest rates. At the start of 2013, the rate stood at 7.9%. Since then it has fallen to its current level of 6.7%, but not always for the right reasons.

“Markets expect another $10 billion reduction in bond purchases, and, while the Fed may change its language to de-emphasize the 6.5% unemployment rate threshold, it will likely try to do so in a way that doesn’t change expectations surrounding the timing of the first fed funds rate hike,” said Kelly.

Fed officials -- notably and repeatedly former Fed chief Ben Bernanke -- have acknowledged that the headline unemployment doesn’t necessarily reflect the overall health of U.S. labor markets, let alone represent an accurate barometer for the health of the U.S. economy.

Consequently, the Fed has said it is placing much more emphasis on an array of economic indicators such as GDP and inflation to help them determine future policy and guidance rather than placing too much emphasis on the unemployment rate.

In any case, the Fed’s timing message hasn’t wavered much: policy makers have said interest rates will remain at their historic low levels for the foreseeable future in order to maintain so-called “highly accommodative polices” that continue to promote lending and spur economic growth.

Lawson said it’s unlikely the Fed will establish any new threshold numbers for raising interest rates. In the first place the Fed loses credibility if once again a threshold is reached before rates are ready to be raised. Also, Lawson said he doubts there is broad agreement among Fed members over what the threshold targets might be.

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