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With economy hazy, Fed is unlikely to shift course

Janet Yellen

Federal Reserve Chairwoman Janet Yellen appears before the Senate Budget Committee to examine the nation's economic and fiscal outlook, on Capitol Hill in Washington, May 8, 2014. This week’'s Federal Reserve meeting is the third at which Yellen will preside as chairwoman since succeeding Ben Bernanke in February. (AP Photo/J. Scott Applewhite, File)

By
June 18, 2014 |

WASHINGTON — When Federal Reserve officials gather this week and Fed Chair Janet Yellen speaks with reporters, investors will be seeking clues to two big questions:

When will the Fed finally start raising short-term interest rates?

And how – and when – will it start unloading its vast investment holdings?

The answers will affect loan rates for individuals and businesses – and perhaps the direction of the economy. Yet few expect to hear anything definitive.

The Fed remains in a tentative wait-and-see stance.

Though the central bank has signaled optimism, officials are unsure how much the economy will strengthen the rest of the year. On Wednesday, the Fed will update its forecasts, and it may downgrade its estimate of growth for 2014 after the government said last month that the economy shrank in the first quarter, depressed by a harsh winter.

On Monday, the International Monetary Fund predicted that the U.S. economy will grow a modest 2 percent this year, below the IMF’s previous estimate of 2.7 percent.

Yellen has suggested that the U.S. unemployment rate, now 6.3 percent, overstates the health of the job market and economy. She’s also expressed concern that a high percentage of the unemployed – 35 percent – have been out of work for six months or more and that pay is scarcely rising for people who do have jobs.

Yet the Fed is getting closer to acting. The minutes of its last meeting in late April indicated that the Fed has begun discussing the tools it could use to finally pull back the extraordinary stimulus it’s provided the U.S. economy since 2008.

This week’s meeting is the third at which Yellen will preside as chair since succeeding Ben Bernanke in February. Analysts expect at least one announcement when the two-day policy meeting ends Wednesday: That the Fed will make a fourth $10 billion cut in the pace of its monthly bond purchases to $35 billion, a sign of a steadily, if slowly, improving economy. The Fed has been buying Treasury and mortgage bonds to try to keep long-term loan rates low to stimulate the economy.

The Fed will likely end its bond purchases this fall, with its investment portfolio nearing $4.5 trillion. But officials have said that even when they stop buying bonds, they don’t plan to start selling any. They plan to keep the Fed’s holdings steady by re-investing maturing bonds. In doing so, the Fed will still exert downward pressure on long-term rates.

The Fed has said it will keep its key short-term rate at a record low near zero for a “considerable time” after its bond purchases end. At her news conference, Yellen will likely avoid being pinned down on how long a “considerable time” might be. Last month, she said the Fed expects to start raising rates once it sees enough progress in restoring full employment and inflation has risen to its 2 percent target rate.

Most Fed members expect the Fed to start raising short-term rates between mid-2015 and 2016. The central bank has stressed that even after it starts raising rates, it will likely keep them unusually low to support the economy.

Minutes of the Fed’s April 29-30 meeting show that officials discussed how best to unwind support for the economy once they begin raising the benchmark short-term rate. The minutes stressed that the discussion shouldn’t be seen as a signal that any rate increase is imminent.

Though the economy may not be growing as fast as the Fed earlier predicted, the job market has shown consistent improvement. Employers have added 200,000-plus jobs for four straight months. The unemployment rate has dropped to a level the Fed hadn’t expected to see until year’s end.

But Yellen has stressed that she is studying barometers of the job market beyond the unemployment rate – from the percentage of long-term unemployed among the jobless to the number of part-time workers who would prefer full-time jobs and the percentage of adults either working or looking for work. By those measures, the job market remains subpar, a reason Yellen has cited for the Fed’s continued support.

Yellen has also expressed worries that the housing recovery may be faltering. In addition, Fed officials have discussed such geopolitical risks as slow growth in Europe and Russia’s aggression toward Ukraine. The newest threat is rising sectarian violence in Iraq, which has sent oil prices up.

Brian Bethune, an economics professor at Tufts University, said that given all the threats that could derail the U.S. economy, the Fed will be careful not to say anything that could push rates up.

“The economy is trying to come back from a very weak quarter,” Bethune said. “The Fed doesn’t want to see long rates go up.”

Bethune said the Fed has leeway to keep rates low because its preferred measure of inflation remains below its 2 percent target.

This week’s meeting will bring new faces to debate the issues. The Senate last week approved the nomination of Stanley Fischer, former head of Israel’s central bank, as the Fed’s vice chair. In addition, Lael Brainard, a former Treasury undersecretary for international affairs, won Senate approval for a vacant board post. Fischer, Brainard and Jerome Powell, who was confirmed for a new term, were all sworn in Monday.

Also, Loretta Mester has succeeded Sandra Pianalto as president of the Fed’s regional bank in Cleveland and will participate for the first time this week.

Analysts see Yellen as firmly in charge of the Fed’s agenda.

“Yellen is still using the Bernanke playbook,” said David Jones, the author of a new history of the Fed. “I think she would like to not raise rates until the fall of next year.”

The Associated Press

The Associated Press

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