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Monday, February 21, 2011

When will the Fed raise rates?

by Calculated Risk on 2/21/2011 05:08:00 PM

Short answer: it is very unlikely that the Fed will increase the Fed funds rate this year. There are a series of steps the Fed will most likely take before raising rates1:

• First the Fed needs to complete the $600 billion “QE2” large-scale asset purchase program. This is currently scheduled to be completed at the end of June, however, to “promote a smooth transition in markets”, it is possible the Fed will decide to "gradually slow the pace" of the purchases like they did with QE1 (quoted text from QE1 related FOMC statements). If the program is extended and purchases tapered off (but the size remains at $600 billion), this will probably be announced at the conclusion of the two day FOMC meeting in late April and the program will probably then be completed in August.

• Next the Fed will end the reinvestment of maturing MBS and Treasury Securities. This could be concurrent with the end of QE2, or the Fed might wait a few more months before halting reinvestment.

• Then the Fed will need to remove or change the extended period FOMC statement:

“The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.”
If we look back to the “considerable period” language in 2003, the FOMC last used the “considerable period” phrase in the December 9, 2003 statement, and the first rate increase was on June 30th, 2004 – just over 6 months later.

This suggests a timeline for the earliest Fed funds rate increase:
• End of QE2 in June (maybe tapered off into August).
• End of reinvestment 0 to 2 months later.
• Drop extended period language a couple months later
• Raise rates in early 2012.

That is probably the earliest the Fed will raise rates - and it could be later in 2012 or even later ...

1 A research note on these steps by Jan Hatzius at Goldman Sachs on Friday lead me to revisit this.