Fed holds funds rate at historic lows, zero to 0.25%

[kscarbel2]

That Yellen feels the need to keep the federal funds rate rates just a hair above zero reflects just how bad the economy continues to be. Pegging the federal funds rate at rock bottom, realistically, reflects an utterly desolate economic picture. Truth be told, the US economy has never been more fragile.

And, as St. Louis Fed President James Bullard has stated, keeping interest rates low for an extended period of time could lead to a Japanese-style deflationary economy........which we do NOT want. This could occur in the event of a shock that pushes inflation down to extremely low levels, perhaps below zero. With the Fed unable to lower rates below zero, actual and expected deflation could persist, which, all else equal, would increase the real cost of servicing debt (ie. incomes fall relative to debt).

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The Financial Times / September 17, 2015

The Federal Reserve held interest rates at historic lows as concerns about an increasingly brittle global economy overshadowed evidence of a resilient US recovery.

The US central bank maintained its 0 to 0.25 per cent target range for the federal funds rate, ending weeks of feverish speculation over whether it would raise rates for the first time since before the financial crisis.

Janet Yellen, the Fed chair, warned that developments in the global economy and markets, which have been rattled by China’s slowdown, may “restrain US economic activity somewhat” as well as pushing down inflation — adding that the Fed was watching for risks of an unexpectedly “abrupt” slowdown in the People’s Republic.

Interest rate forecasts from policymakers suggested that most still expect that the first increase in short-term rates since 2006 will happen this year, but three officials now expect the Fed to hold fire until 2016, and one predicts no move before 2017.

The decision to hold rates at zero to a quarter of a point suggests Fed policymakers remain fearful of crushing a recovery that they have gone to huge lengths to nurture, as they assess fierce headwinds from overseas. These include a 15 per cent rise in the trade weighted dollar in the past year, volatile financial markets, weakening emerging market growth, and signs of the sharp slowdown in China’s economy.

This week’s vote by the Federal Open Market Committee perpetuates an extended period of uncertainty in markets surrounding the timing of the Fed’s first rise, as policymakers take more time to digest the economic impact of August’s violent moves in markets.

Ms Yellen went out of her way to keep the prospect of a 2015 increase on the table, telling a press conference that a rise had been discussed at Thursday’s meeting.

But unexpectedly dovish signals from the statement spurred some investors to bet that the central bank could stay on hold for another four months. Interest rate futures indicated an almost even chance that policymakers move for the first time at their January meeting, according to Bloomberg data.

The dollar dropped and Treasury yields fell after the announcement. “The wait for Godot goes on,” said Luke Bartholomew, a fund manager at Aberdeen Asset Management. “Janet Yellen’s caution won out over some of her more trigger-happy colleagues. There’s good reason for that caution. Inflation is almost non-existent and wage growth is lacklustre.”

The decision to hold comes despite calls from central banks in some emerging markets for the Fed to bring an end to the endless speculation about its first increase in almost a decade. On the other side of the argument, both the International Monetary Fund and the World Bank have been calling for the Fed to hold fire, in part because of fears over the impact a rise could have on fragile emerging markets.

The Fed only has two more meetings left this year — in October and December — if it is to meet Ms Yellen’s previous guidance that an increase is likely in 2015, and Ms Yellen underscored the importance of continued improvements in labour market data in driving deliberations.

One voting member — Richmond Fed president Jeffrey Lacker — voted for a quarter-point rise at Thursday’s meeting.

The Treasury market had rallied strongly ahead of the Fed’s announcement, anticipating the decision to refrain from tightening monetary policy. The two-year Treasury yield fell from 0.81 per cent earlier on Thursday to 0.68 per cent, and the 10-year government bond yield dipped by 10 basis points to 2.19 per cent.

The main dollar currency index plunged by 0.9 per cent, the most in almost a month, while the S&P 500 index of US equities gave up initial gains to close down 0.3 per cent.

Ms Yellen stressed slowing growth in emerging markets as an important factor in Thursday’s discussions, adding that market volatility had been heightened in part by worries about the adeptness of the Chinese authorities’ response.

While, as in previous meetings, the Fed said risks to the outlook were “nearly balanced”, it added on Thursday that it was “monitoring developments abroad”.

Projections released with the statement showed that some 13 of Fed policymakers expect a rate rise in 2015, down from 15 previously. Three others are looking for firming to occur in 2016, and one further out in 2017.

Officials’ median estimate for the federal funds rate was lowered this year to 0.375 per cent, indicating policymakers still expect one rise this year. The estimate for 2016 was 1.375 per cent, down from 1.625 per cent previously, while the 2017 estimate was 2.625 per cent, down from 2.875 per cent.

The longer-run estimate for the funds rate was lowered a quarter point to 3.5 per cent, as many analysts expected, reflecting the continued headwinds facing the US economy. One policymaker advocated negative interest rates, projecting a range from zero to -0.25 per cent.

Reflecting America’s resilient domestic economy, projected unemployment numbers were stronger across the forecast, with the median forecast rate tipped to fall below 5 per cent to 4.8 per cent in 2016 and 2017. Policymakers’ median estimate for the longer-run jobless rate was 4.9 per cent, down from 5 per cent previously.

Fed policymakers lifted their economic forecast for 2015 on the back of this year’s steady activity numbers, pencilling in a median 2.1 per cent growth, up from 1.9 per cent previously.

However growth estimates were pared back in 2016 to 2.3 per cent from 2.5 per cent — probably in part due to a stronger dollar. Inflation stripping out energy and food was also trimmed slightly to 1.7 per cent in 2016 and 1.9 per cent in 2017.

[kscarbel2]

Fed gets harder to read

Reuters / September 17, 2015

The Federal Reserve held interest rates near zero on Thursday, raising questions over how it will ever manage to lift them off the floor and how effectively it will communicate plans to do so.

Only just over half economists polled have predicted such an outcome, a rare occurrence, and a sign of just how hard it has become to read the Fed these days.

Prior to the rate decision, Fed Chair Janet Yellen had not spoken in almost two months. Two of her closest allies had spoken late last month but delivered seemingly contradictory messages just days apart.

After the decision, Yellen said while it was an "unfortunate state of affairs" that every comment by a Fed official is parsed for hints about the Fed's next move, "uncertainty in financial markets" is natural when a policy shift is near, as it is today.

Policymakers do not, she said, try to make up their minds on a daily basis based on the economic release of the moment, but use their regular meetings to take stock of the accumulated information and make a decision from there.

"We do our darndest to pull together the best analysis we can," Yellen told a news conference.

The issue appears to be how Yellen manages the rate setting body. Like her predecessor Ben Bernanke she listens to others before speaking at the open markets committee and she appears to value forming consensus, shown by the fact that there was just one dissent in Thursday's vote.

The language used by the Fed is aimed at giving it a high degree of flexibility when it comes to rate decisions.

That may now be a weakness when it comes to communicating where the Fed is in situations in which it might need to pivot in response to developments such as the recent market turmoil in China and beyond, possibly leading to continued volatility in financial markets.

For months the Fed has said it will only raise rates once it is "reasonably confident" that inflation will rise back to its 2-percent target. At the same time, it has said it "expects" it will rise toward that rate, despite continued misses, and without spelling out what more information would be needed.

"I think the Fed has muffed the communication going into this meeting," said Lou Brien, analyst for Chicago trading firm DRW Holdings. "They could have offered more clarity."

Markets were pricing in a one-in-four chance of a 25 basis point rate rise ahead of Thursday's meeting, according to the CME Fedwatch tool.

TOWER OF BABEL

The mixed messages in recent months mark a departure from Yellen's pledge in an April 2013 speech to end the days of "never explain, never excuse", when she said the Fed would "reap the benefits of clearly explaining its actions to the public".

Yellen earlier this year became a convert to so-called data-dependent policy-making. The idea was that the Fed would say what the economic data should look like before it tightens policy allowing the public to try to figure out if incoming data met that bar.

In August, the New York Fed president William Dudley suggested that turmoil in global financial markets meant the chances of a September rate hike were receding. Just days later Fed Vice President Stanley Fischer left the door to a rate rise open.

That made the Fed look like a "Tower of Babel," said Wells Fargo economist John Silvia.

Still, not all investors were thrown by the Fed's lack of clarity. In their view, Fed policy-setters simply cannot make the kind of guarantees on rates that they used during the depths of the recession.

And with data - and global financial turmoil - pushing the Fed is different directions, Yellen may have made the right choice in staying silent, rather than risk appearing to be overly swayed by one economic data or another.