Thursday, June 13, 2013

WSJ: "Fed Likely to Push Back on Market Expectations of Rate Increase"

by Calculated Risk on 6/13/2013 04:13:00 PM

Jon Hilsenrath at the WSJ writes: Analysis: Fed Likely to Push Back on Market Expectations of Rate Increase

“The market is saying, ‘The fundamental economic outlook really hasn’t changed much, but we are getting more worried about Fed policy,’” says Jan Hatzius, chief economist at Goldman Sachs.

Since last December the Fed has been promising to keep short-term interest rates near zero until the jobless rate reaches 6.5%, as long as inflation doesn’t take off. Most forecasters don’t see the jobless rate reaching that threshold until mid-2015.
Actually the Fed has said they'd hold interest rates low until at least 6.5%. Here is the FOMC wording:
[T]he Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.
Back to Hilsenrath:
At the same time, however, the Fed is talking about pulling back on its $85 billion-per-month bond-buying program. The chatter about pulling back the bond program has pushed up a wide range of interest rates and appears to have investors second-guessing the Fed’s broader commitment to keeping rates low.

This is exactly what the Fed doesn’t want. Officials see bond buying as added fuel they are providing to a limp economy. Once the economy is strong enough to live without the added fuel, they still expect to keep rates low to ensure the economy keeps moving forward.

It’s a point Chairman Ben Bernanke has sought to emphasize before. The Fed, he said in his March press conference and again at testimony to Congress last month, expects a “considerable” amount of time to pass between ending the bond-buying program and raising short-term rates.

He seems likely to press that point at his press conference next week, given that the markets are telling him they don’t believe it.
It is possible the Fed will start tapering bond purchases in September, although, right now I think it will be towards the end of the year or in 2014.  And I think the FOMC means it when the say a "considerable" amount time will pass between the end of QE3 and raising rates.  So market expectations are probably wrong.

Note: A few years ago, market expectations at each point were that the Fed was going to raise rates in six months - always six months, and that incorrect expectation was one of the reasons the Fed worked to improve their communications and eventually added a statement in January 2012 about keeping rates low until at least 2014. They revised their statement again and added thresholds for raising rates. It is pretty clear the Fed Funds rate will be low for a considerable time, and market expectations appear wrong again.