March 18, 2015
This was not your standard stay-the-course announcement from the Fed. While no policy changes were made as a result of the Federal Open Market Committee meeting that ended today -- indeed, the Fed all but promised there would be no changes at the next meeting either -- the Fed may have sharpened the focus on when it will finally raise interest rates.
Key wording changes put a target on June's meeting
Particularly when the Fed has had no policy changes to announce, statements following its meetings tend to have a certain sameness to them -- indeed, some of the language has been identical from one meeting to the next. However, this time there were some surprises.
Not only did the Fed announce that it was not raising interest rates at this meeting, but it took the unusual step of stating that a rate increase at the next meeting (which is in April) is unlikely as well. Normally, the Fed uses fuzzier language than that, shying away from committing to what it will or won't do at any particular future meeting. This is not because the Fed likes being coy. Rather, by shying away from specific commitments the Fed retains the greatest latitude to adapt policy to changing conditions.
In a sense, downplaying the possibility of a rate hike in April can be seen as an attempt to alleviate the usual market jitters that lead up to a Fed meeting. However, if the Fed took some pressure off of April's meeting, it put something of an investor target on the following meeting in June.
This is not simply because the Fed's commitment to current rate levels did not extend beyond the April meeting. Another significant wording change in today's statement involved the Fed's monitoring of inflation. One reason the Fed has given for keeping interest rates low is that inflation is running below its target rate of 2 percent. However, while reiterating this in today's statement, the Fed also explained that it might raise rates when it "is reasonably confident that inflation will move back to its 2 percent objective over the medium term."
This suggests that the Fed might not wait for inflation to reach 2 percent, but might raise rates if it believes inflation is headed back in that direction. In particular, this puts added focus on oil prices, which have been a leading cause of the recent bout of deflation. It also puts further attention on the Fed's June meeting.
The waiting game
Don't expect to see an immediate impact on bank rates from today's Fed meeting, but since they are clearly entertaining the possibility of a rate hike as early as midyear, this could push savings account rates higher in the second half of this year.
The bad news for consumers is that mortgage rates might move higher even sooner. In fact, if the Fed is right about inflation firming up, mortgage lenders will probably not wait for the Fed to start raising their rates.
January 28, 2015
Once you brush aside the dusty economic jargon, today's concluding statement from the latest Federal Open Market Committee meeting was positively sunny. Just don't expect the stock market to see it that way.
Meanwhile, today's statement leaves the outlook for bonds and bank rates mixed.
What the Fed didn't say may be the big news
The sunny side of the Fed's statement is that it sees economic growth as solid, and notes continued improvement in employment. The Fed even was willing to dismiss recent signs of deflation. Though the Fed has repeatedly expressed concern about inflation running below its 2 percent target, today's statement notes that price increases should firm up as energy prices stabilize and as the labor market moves closer to full employment.
That optimism might be the reason for what the Fed didn't say in today's statement, and sometimes it is what the Fed doesn't say that markets and commentators seize upon. In recent meetings, Fed meeting statements had mentioned an expectation of keeping short-term rates near zero "for a considerable time" following the end of its latest quantitative easing program. Today's statement did not include that language.
What does that mean? At face value, and couched in all the usual qualifiers of these Fed statements, it simply means the Fed is leaving itself free to adjust as conditions change. However, in removing a commitment to keeping rates low for a considerable time, it could be argued that the Fed is anticipating an imminent change in conditions.
Implications for stocks, bonds and savings account rates
Low interest rates have created demand for stocks, and while nothing in the Fed's statement changed the low rate policy, stocks are long-term investments. The removal of the commitment to keep rates low "for a considerable time" might start some investors looking for an exit before rates start to rise. Plus, the stock market has become positively greedy for Fed stimulus, and the Fed's sanguine outlook for the economy -- despite recent deflation and global woes -- would seem to quash the hope of new stimulus anytime soon.
Bond investors might take hope in the Fed's plan to continue to roll over the mortgage-backed and Treasury securities acquired during its massive quantitative easing program. This means that while the Fed is no longer adding to its inventory of those securities, it is also not in a hurry to sell off those securities. That should give the bond market some measure of stability in the near term, though long-term bond holders should be concerned about volatility once the Fed shifts to a less generous policy or inflation starts heading toward more normal levels.
Meanwhile, the Fed's continued policy of low short rates will bring no immediate relief to depositors facing today's near-zero savings account rates and other bank rates. The bright spot for these depositors is that the Fed's change of language on low rates hints that higher deposit yields could soon appear on the horizon.
December 17, 2014
It is the financial sector's biggest spectator sport: guessing what the Fed will say and do at the conclusion of each Federal Open Market Committee meeting.
Today's meeting brought only a change in words, not deeds. Often, however, that is enough to send markets scrambling.
Federal Reserve wordplay
The key wording change involved backing away from a phrase the Fed had been using to characterize how long it planned to keep short-term rates near zero. "For a considerable time" had been the recurring refrain, but this time the Fed merely said it expected to be "patient" in deciding when to return rates to more normal levels. However, as if concerned that even this was too rash a change in wording, the Committee went on to say it felt this stance consistent with its earlier pledge to keep rates near zero for a considerable time.
What is probably more significant than this bit of wordplay about rates is what the Fed had to say about the conditions that will drive its policy going forward -- specifically, employment and inflation.
The Fed notes expressed satisfaction with progress in the labor market, and indeed, job creation has been on a roll throughout most of 2014. One could even infer that the Fed would have been ready to raise short-term rates if it were not for the other major component of the Fed's mandate, which is price stability. Here, the Fed continued to express concerns that inflation has been too low.
The Fed meeting ended on a day when the Bureau of Labor Statistics announced that the Consumer Price Index had declined by 0.3 percent in November, and had gained only 1.3 percent over the past year. This once again raises the specter of deflation, which has been a major reason why the Fed has been hesitant to raise rates. The chief culprit in the recent drop in prices is the falling value of oil.
Still, there is reason for hope. The Fed notes say they expect inflation to firm up as the labor market continues to improve, and it describes the impact of lower energy prices as "transitory."
Implications for rates
In total, the Fed's latest comments seem to suggest that the Fed would not be surprised if rates were to rise in 2015. Employment is already on track, and inflation is likely to rebound as the labor market strengthens and as prices get past the temporary impact of the collapse in the oil market. In that scenario, expect mortgage rates to move first, because they have to anticipate a long-term time horizon. Shorter-term rates like savings account rates can afford to play more of a waiting game.
The main potential snag in this scenario is if oil does not stabilize in 2015. This would bring more deflationary pressure to bear, and could be indicative of enough global economic weakness to set off another stretch of low rates.
October 29, 2014
Quantitative easing is officially over -- or is it?
Not surprisingly, the Federal Reserve today finally announced the end of its program to bring long-term interest rates down via purchases of Treasury bonds and mortgage-backed securities. However, until the Fed sells those securities or at least starts letting them mature without repurchasing new ones, the impact of that program will not be entirely reversed.
Beyond a discussion of the quantitative easing program, there were two striking things about the latest statement from the Federal Open Market Committee (FOMC): One is the almost exclusively domestic focus of its discussion of economic affairs, and the other is that it seemed to condemn savings account rates and other bank rates to trailing inflation for the foreseeable future.
All quiet on the home front
The Fed cited a number of domestic economic factors that seem to be going well. These included:
- Solid job gains leading to a lower unemployment rate.
- Improvement in the utilization of labor resources (i.e., less under-employment).
- A moderate rise in household spending.
- Growth in business fixed investment.
It is an encouraging list of developments. Not mentioned anywhere, however, are rising concerns about recessions in Europe and slowing growth in large developing economies. That slower growth seems almost certain to hurt U.S. exports, especially with the rise in the dollar over recent months. Of course, supporting the world economy is beyond the Fed's mission, but it is surprising to see no caution about the effect of the broader environment on the growth factors cited by the Fed.
The Fed may simply be keeping its focus narrowly on domestic affairs, and does not want to speculate on international ones until or unless they start to measurably impact the U.S. economy. Or, it may be implicitly expressing confidence that the U.S. economy has gained enough strength to weather an international slowdown.
No love for savings account rates
While the quantitative easing program was largely focused on bringing mortgage rates down, consumers with savings accounts and other bank deposits should be more attentive to the part of the FOMC statement that addressed the federal funds rate, because this has more of a direct influence on short-term bank rates.
The Fed said that it expects to maintain the federal funds target between 0 and 0.25 percent "for a considerable time." While that is an appropriately vague statement (conditions are too unpredictable for the Fed to lock into a specific timetable), it is noteworthy that the Fed specified it expects to maintain that low range as long as inflation continues to run below its target of 2 percent.
Translation: If the Fed has its way, inflation will reach 2 percent before short-term interest rates do. That means investors in deposit accounts can expect their interest rates to continue to trail inflation. Until the Fed gains confidence that low inflation is not a problem, the best hope depositors have for better bank rates is to shop around for them.
September 17, 2014
They say nothing takes longer to turn around than an oil tanker. Federal Reserve policy might give those boats some serious competition.
The Fed concluded its latest meeting today with an announcement that indicates the transition from stimulative to neutral policies is continuing -- just very slowly. With the economic recovery still in uncertain health more than five years after the end of the Great Recession, you could argue about how effective the Fed's policies have been, but for that same reason, their reluctance to make any sudden changes is understandable.
The latest Fed policy changes
Low interest rates are a traditional monetary tool for stimulating the economy, and the Federal Reserve has lowered both short-term and long-term rates. While the Fed has a fair amount of direct control over short-term rates, it had to influence long-term rates by buying long-term bonds. It is this long-term rate policy that the Fed has been backing away from throughout this year.
Continuing the pattern from recent meetings, the Fed announced that it will trim those purchases by another $10 billion per month, leaving the total ongoing purchases at $15 billion. Thus this tactic to bring down long-term rates has almost run its course, though until the Fed starts selling the securities it has already accumulated (or at least letting them mature without reinvestment), there may not be immediate upward pressure on long-term rates.
As for short-term rates, the Fed is keeping them firmly near zero, and anticipates continuing to do so for a "considerable time" after its asset purchases have ceased. For consumers, this means mortgage rates are more likely to rise than savings account rates.
How healthy is the economy?
The shift -- subtle though it is -- in Fed policy is based on the premise that the economic recovery is strong enough to survive without some of the stimulative support it has been receiving from the Fed. Unfortunately, some recent developments have cast some doubt on this premise:
- Employment growth for August was below par.
- Purchase mortgage applications recently fell to their lowest level since February.
- Consumer prices declined in August.
When the Fed has kept the economy on life support for so long, it is worrisome to see the patient gasping for breath when just a little of that life support has been removed so far.
Why not just keep a foot on the gas?
If the economy is in questionable health, why not just keep stimulative policies in place? It may be that the Fed is worried about the build-up of the type of excesses that led to the financial crisis six years ago. The stock market has soared to record highs on the strength of low interest rates, and borrowing in many forms has also reached record levels.
Therefore, the Fed may be looking for a formula that encourages economic growth without encouraging risk-taking. That has always proven to be a difficult balance to achieve.