One question newly-installed Federal Reserve Chairwoman Janet Yellen is sure to face at this week's monetary policy hearings on Capitol Hill is what the rapidly falling unemployment rate means for the central bank's stimulus policies.
The unemployment rate fell to 6.6 percent in January, the Labor Department reported Friday. That is just above the 6.5 percent rate that the Fed for over a year said would be the threshold for raising short-term interest rates. And it's well below the 7 percent rate that Yellen's predecessor, Ben Bernanke, once said would be the threshold for ending the Fed's monthly bond purchases, which are still ongoing.
The steeply-falling unemployment rate presents a problem for the Fed because it's been accompanied by relatively weak job growth and an exodus of workers from the labor market. The last two jobs reports, in particular, have come in well below expectations.
The quick obsolescence of the Fed's promise to keep interest rates near zero only until the unemployment rate hits 6.5 percent has led some commentators to suggest that it is running out of tools to stimulate growth.
In a column published Sunday, the Financial Times' Edward Luce suggested that the Fed's forward guidance -- that is, its promises about future rates -- is "a gun that fires blanks."
But so far, markets show no signs of confusion or disbelief over the Fed's plans for rates. In part that is because Bernanke anticipated that the bank might run into the problem of too-quickly falling unemployment.
Before he left office, the Fed clarified that rates would remain near zero until "well past the time" that unemployment hit 6.5 percent.
He appears to have convinced investors that 6.5 percent unemployment won't mean rate hikes.
Based on implicit yields in the eurodollar futures market, investors expect short-term rates to be just under 1 percent by the end of 2015 and just under 2 percent by the end of 2016. That tracks Fed officials' own projections, as outlined after their December meeting. The "Federal Funds Rate" is the official name of the short-term lending rate targeted by the Fed:
In an interview with the Wall Street Journal, Boston Fed president Eric Rosengren, considered one of the more dovish members of the Fed's monetary policy committee, said it was surprising that the unemployment rate had fallen so quickly, but that “[t]he markets are pretty in tune with what we're trying to communicate.”
The weak jobs reports for December and January won't change the Fed's strategy, Rosengren suggested.
He hinted, however, that the Fed could update its forward guidance in the future to focus on measures of "underutilization" in addition to unemployment if the jobless rate keeps dropping too quickly for the purposes of Fed communication. He did not, though, clarify which indicators those would be.