Federal Reserve Chairwoman Janet Yellen and other central bank officials are likely to end their large-scale bond-buying program this week, while simultaneously promising lower interest rates for longer to stimulate the economy.
As members of the Federal Reserve System converge in Washington on Tuesday for a two-day meeting that will culminate with an official monetary policy statement, they are set to cut the last $15 billion of monthly bond purchases to zero, ending the stimulus program that began in late 2012 and has seen the Fed’s balance sheet expand from $2.8 to $4.5 trillion.
Amid slowing inflation, volatile financial markets and a weakening global economy, however, the Fed is now expected to delay raising short-term interest rates for even longer to provide additional monetary easing. The Fed has kept rates near zero since the financial crisis hit in 2008.
Investors expect that Fed officials will signal a slower move to raise rates with its statement, which will be published at 2 p.m. on Wednesday. They could do that merely by acknowledging any of the negative economic developments since the last Fed meeting in September.
“They might have to tweak, basically, the language to reflect the fact that if inflation remains below target or progress has not continued as anticipated, there might be more kind of patience” in raising rates, said Thanos Bardas, the head of global rates atinvestment firm Neuberger Berman.
Yellen and company have said in recent months that they won’t raise short-term interest rates until a “considerable time” after the bond purchases end, and then will base their decision to raise rates on the extent of progress toward the Fed’s goals of normal unemployment and 2 percent inflation.
The signs indicate that there will continue to be progress toward the first goal, said Bardas, citing falling claims for unemployment insurance and rising advertisements for jobs. As a result, the Fed will be confident enough in the labor market to phase out the last of its monthly purchases of Treasury and mortgage-backed securities, which had totaled $85 billion initially and have been steadily reduced throughout the year.
But progress toward the 2 percent inflation goal is less clear, with most measures of inflation falling since the summer and the dollar strengthening rapidly against other currencies. Other factors, especially wild swings in the stock markets and collapsing bond yields, also weigh on the side of greater caution.
“We think the committee will decide to explicitly mention foreign growth concerns and/or financial market volatility” in the statement to reassure investors, wrote Goldman Sachs economist Kris Dawsey in a note on this week’s meeting.
Bond markets already have priced in the expectation that the Fed will react to the recent economic news with language hinting at slightly later rate hikes. Bond market prices suggest that the first rate increases are now expected around September 2015, with some investors anticipating that they could come as late as early 2016.
As a result, explained Deutsche Bank economists Joseph LaVorgna and Brett Ryan in a note published Monday, Wednesday’s statement “should show few meaningful changes from last month’s communiqué.”
LaVorgna and Ryan noted that private-sector projections for interest rates are still below the Fed’s own projections, meaning that investors don’t expect economic growth to pick up, nor inflation to rise, as quickly as some Fed officials do.
That’s a view shared by some members of the Fed monetary policy committee. Speaking just before the enforcement of the two-week blackout rule on Fed officials before monetary policy meetings, Federal Reserve Bank of Minneapolis President Narayana Kocherlakota suggested that the current outlook for inflation means that rate hikes wouldn’t be called for during 2015.
He projects that inflation won’t rise to 2 percent until 2018. “It would be inappropriate” for the committee “to raise the … rate at any such meeting,” said Kocherlakota, generally considered one of the more “dovish” members of the committee.
Nevertheless, not all of the market movements have been bad. Bardas noted in particular that falling oil prices, a product of slowing growth and demand in places such as Europe and elsewhere, will aid the U.S. economy by saving consumers money at the pump. Gasoline on Monday hit its lowest price since early 2011, the AAA motor club reported.
The Fed might acknowledge that oil prices, which fell below $80 a barrel Monday, could stimulate more consumer demand.
On the one hand, headwinds are being created by slowing growth among America’s trading partners in Europe and Japan. “But at the same time the lower energy prices give more discretionary spending power for U.S. consumers,” Bardas said.
