Federal Reserve policymakers will
likely leave interest rates low when they meet next week, despite a
surprisingly sharp drop in U.S. unemployment that points to economic recovery.
The decision last month to reduce the Fed’s bond-buying stimulus was well
received by financial markets and it is likely there will be another $10
billion cut to the bank's monthly bond purchases at the January 28-29 meeting.
The Fed has said it expects to
keep rates near zero until well past the time unemployment falls below 6.5
percent, especially if inflation remains low. Joblessness dropped faster than
expected last year and hit 6.7 percent in December, down from 7.0 percent the
previous month.
Had the drop in unemployment
sparked a selloff in bonds, the Fed might have reinforced its commitment to
stimulus by tampering with its low-rates promise. But investors appear to have
interpreted the data as a one-off event that would not prompt a
quicker-than-expected policy tightening.
With the U.S. economy
strengthening, the Fed wants to shelve its bond-buying program by later this
year. At the same time, wary of false economic starts, it plans to lean more
heavily on its low-rate promise to convince investors it will not tighten
policy any time soon, probably not until well into in 2015.
SHAPING EXPECTATIONS
In December 2012, the Fed announced
it would likely cease its bond-buying program at an unemployment threshold of
6.5 percent. And last month it was announced that rates would likely remain
near zero "well past" that threshold, "especially" if
inflation remains below the Fed's 2 percent target.
One simple way the Fed could help
shape rate expectations is to release Fed officials' rate forecasts more
frequently. The central bank began publishing policymakers' quarterly rate
projections in January 2011.
Right now market views appear to
be in sync with the Fed's own expectations, with traders in short-term rate
futures betting on a first rate hike no earlier than April 2015. Twelve of the
17 Fed policymakers, meanwhile, expect rates to be at or below 1 percent by the
end of 2015.
The Fed also expects unemployment
to drop to between 6.1 and 5.8 percent by the end of next year, with inflation
rising to 1.5 to 2.0 percent - very likely a comfortable environment to raise
rates from rock bottom levels.
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