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As Fed meets, key issues likely to stay unanswered

July 30, 2014
Associated Press

WASHINGTON (AP) — The Federal Reserve will likely end a policy meeting Wednesday with a lot of questions unanswered:

When will it start tightening its benchmark short-term interest rate to make sure future inflation remains under control? How will it do so? And when will the Fed start reducing its enormous investment holdings — a move that will put upward pressure on interest rates?

Chair Janet Yellen gave few hints about the answers to such issues when she testified to Congress this month. And most analysts don't think the central bank will fill in any of the blanks when it ends a two-day meeting with a brief policy statement. There will be no Yellen news conference this time.

One announcement that is expected is that the Fed will make a sixth $10 billion cut in its monthly bond purchases, which have been aimed at keeping long-term rates low.

A key reason is that the economy needs less help now. Hiring is solid, and, at 6.1 percent, the unemployment rate is on the cusp of a historically normal range. Manufacturing is strengthening. Consumers are voicing renewed confidence.

Still, the economy isn't back to full health.

Workers' pay remains flat. Turmoil overseas, from Ukraine to the Middle East, poses a potential threat. And as Yellen noted in her congressional appearance, long-term unemployment remains high and wage growth weak.

For that reason, the Fed is expected to reaffirm its plan to leave its key short-term rate at a record low near zero "for a considerable time" after it ends its bond purchases.

"There are so many uncertainties, both economic and political, that the Fed wants to leave plenty of wiggle room," said Sung Won Sohn, an economics professor at California State University, Channel Islands.

The Fed will almost surely announce that it's reducing its monthly bond purchases from $35 billion to $25 billion. When the Fed started cutting the purchases in December, they stood at $85 billion a month.

The Fed intends to end its new purchases by October. By then, its investment portfolio will be nearing $4.5 trillion — five times its size before the financial crisis erupted in September 2008.

After the crisis struck, the Fed embarked on bond purchases to try to drive down long-term rates and help the economy recover from the Great Recession. Even after its new bond purchases end, the Fed has said it will maintain its existing holdings, which means it will continue to put downward pressure on rates.

The Fed has kept its target for short-term rates near zero since December 2008. Most economists think it will start raising rates by mid-2015, though some caution that the Fed could do so sooner if the economy keeps generating jobs at a robust pace. There have been five straight months of 200,000-plus job growth.

Mark Zandi, chief economist at Moody's Analytics, said he thinks chronically lagging pay growth, in particular, will stop the Fed from raising rates before mid-2015.

Besides discussing short-term rates, Fed officials this week are likely debating how to unwind their investment holdings. They face a delicate task in shrinking the portfolio to more normal levels without destabilizing markets. The Fed's bond purchases allowed it to inject money into the financial system, which wound up as reserves held by banks and helped keep loan rates low.

To reverse that process and raise borrowing rates, the Fed is considering a variety of tools. One would be to increase the interest it pays banks on excess reserves they keep at the Fed.

David Jones, author of a new book on the central bank's 100 year history, said any new exit details might not be revealed until the Fed releases the minutes of this week's meeting in three weeks. Those minutes, Jones said, "may be the most interesting thing to come out of the meeting."

 
 

 

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