Fed Keeps Interests Low At Least Until Late 2014

The Fed delivered a dovish policy statement in January, stating the Fed funds rate will stay at exceptionally low level ‘at least through late 2014’. There were two other notable changes made at the meeting. First, the Fed released interest rate projections of participants. Second, the central bank released a statement on its longer-run goals and strategy, indicating a 2% long-run target for the PCE deflator. The dovish tone of the statement and the press conference was a reflection of the highly uncertain global economic outlook which was supported by FOMC’s downward revision in growth forecast over the next three years. We retain the view that the Fed will implement QE3 in the second half of this year, after completion of operation twist.

Policymakers pledged to maintain a ‘highly accommodative stance for monetary policy’ so as to bolster economic growth and to keep inflation at levels consistent with the dual mandate over time. While acknowledging recent improvement in economic indicators, the Fed stated that ‘unemployment rate remains elevated’, growth in business fixed investment has ‘slowed’ while the housing sector remains ‘depressed’. In light of the situation and global financial strains, the Fed believed that exceptionally low levels for the federal funds rate are warranted ‘at least through late 2014’, a period longer than the previously stated ‘mid-2013’.

Regarding policy projections of the 17 members, 3 anticipated the first rate hike this year, 3 anticipated next year, 5 in 2014, 4 in 2015 and 2 in 2016. The distribution of projections was rather flat with most expecting a rate hike at least in 2014 or after. Fed Chairman Ben Bernanke said that the forward guidance should be given priority over the projections as the former is a policy statement agreed to by the FOMC while the latter is just an aggregation of forecasts.

The Fed specified a longer-run goal for inflation 2%, measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Fed’s mandate. Announcing such a goal to the public is expected to help ‘fostering price stability and moderate long-term interest rates’, as well as ‘enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances’. The reason for not communicating a goal for unemployment rate is that the Committee believed that the maximum level of employment is due to nonmonetary factors which may change over time and are not directly measurable.

The message sent out by the Fed was dovish and purposely to pave the way for further easing. As Bernanke indicated, if ‘unemployment progress is very slow,’ then ‘there is a case for additional policy action’. We retain the view that QE3 will be adopted this year but it will wait after operation twist is over unless market conditions deteriorate markedly.

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