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Janet Yellen declared that the Federal Reserve wasn’t changing policy when it overhauled the method it signals alterations in borrowing costs. Investors didn’t doubt it.
In her first press conference as Fed chair yesterday, Yellen discussed that relinquishing a 6.5 percent jobless threshold for acknowledging an interest-rate hike “does not indicate any change in the committee’s policy intentions.”
Rather than giving heed to Yellen’s assertion, investors seized on a hike in Fed officials’ own interest-rate projections and Yellen’s remarks that borrowing costs could begin soaring “around six months” after it stops purchasing bonds. Yields on two-year Treasury notes spiked higher as much as 10 basis points yesterday, the highest since June 2011.
The market reaction features the risks encountered by central bankers when they pulled back to language investors consider vague after setting precise numerical markers for alterations in policy. Lacking specific guidance in the Fed’s policy statement, investors swung toward the next best thing: Fed officials’ own projections for the standard federal funds rate.
“With the shift to qualitative guidance, the only quantitative metric we have is the fed funds projections from the Fed,” said Dean Maki, chief U.S. economist for Barclays Plc in New York and formerly an economist at the central bank. “So while the statement and Chair Yellen in the press conference said little had changed, the Fed’s projections suggested that there was a notable change in the Fed’s outlook.”
Broad Range
Treasuries were slightly altered today, with the yield on the two-year note at 0.42 percent at 4:34 p.m. in New York and the yield on the benchmark 10-year note at 2.77 percent. The spread between yields on the two-year note and the 30-year bond, known as the yield curve, narrowed to 324 basis points today, the least on a closing basis since February 3.
The Federal Open Market Committee announced it will no longer connect borrowing costs to a particular jobless rate, stating that it would instead acknowledge a broad range of indicators on the labor market, inflation and monetary markets.
“We know we’re not close to full employment, not close to an employment level consistent with our mandate, and unless inflation were a significant concern, we wouldn’t dream of raising the federal funds rate target,” Yellen said at the press conference in Washington.
New Projections
Separately, the Fed released new estimates displaying more officials predicting the benchmark rate, now close to zero, would soar at least to 1 percent at the end of 2015 and 2.25 percent by the end of the following year, greater than previously projected. Those numbers are according to the median estimates of 16 Fed officials.
This month, 10 policy makers computed the benchmark lending rate would be 1 percent or greater at the end of 2015, jump from seven in December. Twelve policy makers predicted the rate would be 2 percent or greater at the end of 2016, jump from eight. The overall amount of projections sagged down to 16 this month from 17 in December.
Yellen downplayed the quarterly estimates, which are shown as a series of dots on a chart.
“One should not look to the dot-plot, so to speak, as the primary way in which the committee wants to or is speaking about policies to the public at large,” she said, adding that the FOMC remarks should take precedence over the estimates.
Market Reaction
“She really tried to talk it down,” said Michael Hanson, senior U.S. economist at Bank of America Corp. in New York and a former Fed economist. “So I think the markets left saying, ‘Well wait a second, what are we supposed to listen to?’”
Stock benchmarks extended pullbacks after Yellen, responding to a question, indicated that the federal funds rate might begin to soar about six months after the central bank stops its bond-purchase program.
The FOMC statement repeated that the rate will stay low for a “considerable time” after asset purchases end. Asked how long that might be, Yellen said: “you know, this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing.”
She added that “it depends on what conditions are like,” and that if inflation “is persistently running below our 2 percent” goal, that would be “very good reason to hold the funds rate at its present range for longer.”
Inflation calculated on a 12-month basis has been under the Fed’s 2 percent target for almost two years, and financial values rallied just 1.2 percent for the year ending January. Still, monetary markets ignored her caveat.
Rebuilding Guidance
The Fed is rebuilding its most particular guidance ever on the benchmark lending rate after jobless decreased toward 6.5 percent, its past threshold for a rate hike, faster than policy makers assumed.
“The committee has never felt that the unemployment rate is a sufficient statistic for the labor market,” Yellen said at the press conference. “It’s appropriate to look at many more things, and that’s why the committee now states we will look at a broad range of information.”
The FOMC declared a $10 billion trim down in monthly bond-purchasing to $55 billion and repeated that it will taper purchases “in further measured steps at future meetings.” At the same time, “asset purchases are not on a preset course.” The committee declared $10 billion slash downs in purchases at the past two assemblies.
‘Weakens Credibility’
“Growth in economic activity slowed during the winter months, in part reflecting adverse weather conditions,” the Fed said. Even so, “there is sufficient underlying strength in the broader economy to support ongoing improvement in labor-market conditions.”
Minneapolis Fed President Narayana Kocherlakota dissented, saying the statement “weakens the credibility of the committee’s commitment to return inflation to the 2 percent target from below and fosters policy uncertainty that hinders economic activity.”
Yellen replied to the dissent in her press conference, saying the committee is “fully committed” to the 2 percent inflation goal.
“We do not want to undershoot inflation for a prolonged period of time,” she said.
Seventy-six percent of economists in a Bloomberg survey March 14-17 guesstimate that the Fed would drop its jobless threshold. Economists also assumed a $10 billion trim down in the monthly pace of bond purchases, based from the median of responses.
Asset Purchases
Yellen, 67, succeed as Fed chair last month after three years as deputy to Ben S. Bernanke. In that position, she aid shape the communications policies the Fed wielded as it sought to nurture a recovery from the worst recession since the Great Depression.
After slashing down interest rates to zero in 2008, the Fed embarked on large-scale asset purchases as well as forward guidance intended to persuade investors that borrowing costs would stay low for a long time.
Beginning in December 2012, the FOMC stated that the federal funds rate would stay low at least as long as jobless was greater than 6.5 percent and the outlook for inflation didn’t surpassed 2.5 percent.
With the unemployment rate at 6.7 percent last month, that guidance was fast becoming obsolete.
