Federal Reserve might tip its hand on future of short-term interest rate
WASHINGTON — When the Federal Reserve offers its latest word on interest rates this week, few think it will telegraph the one thing investors have been most eager to know: When it will slow its bond purchases, which have kept long-term borrowing rates low.
The Fed might choose to clarify a separate issue: When it may raise its key short-term rate. The Fed has kept that rate near zero since 2008. It's said it plans to keep it there at least as long as unemployment remains above 6.5 percent and the inflation outlook below 2.5 percent.
Unemployment is now 7.6 percent; the inflation rate is roughly 1 percent.
Chairman Ben Bernanke has stressed that the Fed could decide to keep its short-term rate ultra-low even after unemployment reaches 6.5 percent. Testifying to Congress this month, Bernanke noted that a key reason unemployment has declined is that many Americans have stopped looking for jobs. When people stop looking for work, they're no longer counted as unemployed.
If that trend continues, Bernanke said that lower unemployment could mask a still-weak job market and that the Fed might feel short-term rates should stay at record lows.
In the statement the Fed will issue when its two-day meeting ends Wednesday, it could specify an unemployment rate below 6.5 percent would be needed before it might raise its benchmark short-term rate. It might say that it won't raise that rate if inflation remains below a specific level.
Investors would react to any such shift in the Fed's guidance. Financial markets have been pivoting for months on speculation that the Fed will or won't soon slow its $85-billion-a-month in Treasury and mortgage bond purchases. Those purchases have led more consumers and businesses to borrow, fueled a stock rally and supported an economy slowed by tax increases and federal spending cuts.
The Fed has signaled that it might slow its bond buying as soon as September — if the economy has strengthened as much as the Fed has forecast. If not, the Fed would likely maintain its stimulus.
On Wednesday, the government will report how fast the economy grew in the April-June quarter. Most economists predict an annual rate of barely 1 percent — far too weak to reduce unemployment quickly. Most think the growth is picking up in the second half of the year on the strength of a resurgent housing market, stronger auto sales, steady job gains and higher pay.
Many economists think the key goal of the Fed's policy discussions Tuesday and Wednesday will be to stress that the Fed's actions in coming months will hinge on how the economy fares, not on any timetable.
Some economists think the Fed will be mindful that the Dow Jones industrial average sank more than 500 points in two days after it met in June when Bernanke said the Fed would likely slow its bond-buying this year and end it next year because the economy was improving.
“The Fed is going to try to calm things down,” said Brian Bethune, an economics professor at Gordon College in Wenham, Mass.
Last month, in what was likely his last economic report to Congress, Bernanke said that even after the Fed has begun slowing its bond purchases, its policymaking will keep lending costs down. Besides keeping its short-term rate low, Bernanke stressed that the Fed will maintain its vast investment portfolio — which exceeds $3.4 trillion —to help keep long-term borrowing costs down.
Some economists still think the Fed will start trimming its bond purchases at its Sept. 17-18 meeting. Unlike this week's meeting, the September meeting will be followed by a news conference in which Bernanke could explain the actions.
Diane Swonk, chief economist at Mesirow Financial, said she believes September is a likely time for the Fed to scale back its bond buying. Yet she doubted it will do anything this week to signal that possibility.
“The less said right now, the better” for financial markets, Swonk said.
David Jones, chief economist at DMJ Advisors, said he still thinks the Fed will start trimming its bond purchases gradually starting in September. But he thinks that date could slip if the economy doesn't strengthen over the next two months. Other economists think the Fed may prefer to wait until after September to trim its purchases to make sure the economy is sustaining its gains.
The Fed's moves to reduce its bond purchases will likely occur just as it will be managing a transition to a new leader. Bernanke is widely expected to step down when his second four-year term as chairman ends Jan. 31.
Vice Chair Janet Yellen is viewed as a leading candidate to replace Bernanke, though former Treasury Secretary Lawrence Summers and others have also been mentioned.
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