The U.S. economy may have achieved a sustainable pace of growth that eases pressure on the Federal Reserve to buy more bonds while giving it time to fine tune how it informs the public about the outlook for interest rates.
“Recent economic data takes away some of the urgency for the need to engage in a new round of quantitative easing,” said Michael Feroli, a former Fed economist who is now chief U.S. economist at JPMorgan Chase & Co. in New York. The Federal Open Market Committee “can say, ‘Let’s wait and see if this is going to build on itself.’”
Since the Fed’s last meeting early in November, reports on employment, manufacturing and retail sales have dispelled concerns the world’s largest economy may slide back into recession. Signs of economic strength, along with coordinated central bank action to alleviate the European debt crisis, last week helped drive the biggest rally in the Standard & Poor’s 500 Index since March 2009.
The FOMC will update its outlook on the economy in its Dec. 13 statement and maintain a pledge to leave the benchmark lending rate at zero until at least mid-2013, Feroli said. Policy makers at their two-day January meeting may announce a strategy for improving how they communicate their policy goals to the public, said Antulio Bomfim, senior managing director at Macroeconomic Advisers LLC in Washington.
Fed officials plan next month to update their quarterly forecasts for growth, inflation and employment. That gives them an opportunity to explain their outlook for the federal funds rate in coming months, said Bomfim, a former senior economist at the Fed and former portfolio manager at Oppenheimer Funds.
Out of Step
Currently, the FOMC’s 2013 interest rate pledge is out of step with both its own economic outlook and investor expectations.
Federal funds futures contracts indicate investors believe the Fed will increase the main rate after mid-2013. Central bank officials expect unemployment of about 8 percent in the fourth quarter of 2013. That’s two percentage points above the high end of their longer-run estimate for full employment of 6 percent.
At the same time, policy makers forecast inflation to be around their 1.7 percent to 2 percent goal by the end of 2013.
Chairman Ben S. Bernanke said at a Nov. 2 news conference that the FOMC statement that day bears “no implication” the Fed plans to raise interest rates in 2013. The committee hasn’t specified any set date for a rate increase, he said.
“The statement says at least mid-2013,” Bernanke said. “So clearly it could well be some point beyond that.”
The U.S. receives its highest rating from international investors in more than two years on optimism the economy will weather the financial crisis in Europe and avoid a recession in 2012, according to the quarterly Bloomberg Global Poll.
Forty-one percent of those surveyed identify the U.S. as among the markets that will perform best over the next year. That’s up from less than one in three who felt that way in September, according to the survey of 1,097 investors, analysts and traders who are Bloomberg subscribers conducted Dec. 5-6.
Bernanke asked an FOMC subcommittee in November to consider giving the public more information about policy makers’ interest-rate outlook. That’s one piece of information that’s missing from officials’ quarterly forecasts.
Publishing participants’ interest rate forecasts would help clarify the mid-2013 conditional pledge because most FOMC members probably expect to tighten after that date, Bomfim said. Such a communications change would also tie their policy outlook more closely to their forecasts for growth, inflation, and unemployment.
“I do think that would be a good move” that would provide slightly more stimulus to the economy, Bomfim said.
Macroeconomic Advisers estimates that a six-month extension of the current near-zero funds rate policy would lower the yield on U.S. 10-year Treasury notes by about 0.2 percentage point, so long as the market isn’t already anticipating such the move. The yield on the 10-year U.S. Treasury note is 2.03 percent.
Extending the rate pledge would put the FOMC’s credibility at risk, said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. Markets may interpret a forecast of the federal funds rate as a statement of policy certainty, when in fact the outlook could be subject to substantial revisions, he said.
Fed officials for the first time published charts in the minutes of their November meeting measuring the risk to their outlook. Sixteen Fed officials said “uncertainty” about the pace of gross domestic product growth was higher, compared with 13 in June, the minutes showed. Eleven said the risks that the unemployment rate would be higher were weighted to the upside, up from nine in June.
The FOMC will want to retain policy flexibility because of the lack of clarity in the outlook, Silvia said.
“Don’t tell me there’s a definite path you’re going to follow in the middle of a storm,” he said. “How clear can you be on policy given the uncertainties in the economy and other policies globally?”
Fed officials also differ over whether publishing a rate path would best serve as a way to alter stimulus or as a way to increase public understanding of the formulation and goals of policy.
“There does seem to be a desire to move away from the” mid-2013 pledge, said Dean Maki, chief U.S. economist at Barclays Capital in New York. Policy makers who tend to favor more stimulus believe the pledge may understate the Fed’s commitment to easing, while officials more concerned about inflation don’t want to promise to keep rates near zero for 18 months, he said.
San Francisco Fed President John Williams said last month that “further forward guidance on our future policy intentions” could be a source of “additional monetary policy accommodation.”
Philadelphia Fed President Charles Plosser, who dissented against the 2013 language when it was introduced in August, said the rate path is mainly a transparency tool rather than a means of easing.
“I’m using this to be transparent about how policy is being conducted,” Plosser, a member of Bernanke’s subcommittee on communications, told reporters last week. “I’m thinking of this as a strategy, not as a means to an outcome.”
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