United States Monetary Policy

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United States: Fed asset purchase program concludes, interest rate hike still dependent on economic improvements

October 31, 2014

At its 28–29 October policy meeting, the Fed’s Open Market Committee (FOMC) announced that its unprecedented asset purchase program known as quantitative easing has concluded. The Fed began its program in November 2008 in an attempt to keep interest rates low and maintain liquidity in the markets. The Fed’s decision to end the stimulus program comes amid improving economic conditions, including steady gains in the labor market. Analysts are now questioning how the Fed will manage and eventually unwind its record USD 4.5 trillion balance sheet, but they are mainly looking for clues as to when it may start boosting the federal funds target rate.

The Fed’s accompanying statement gave a somewhat more upbeat assessment of the economy compared to previous months. According to the Fed, economic growth continues to expand at a moderate pace and there has been substantial improvement in the labor market. In addition to solid job gains and a lower unemployment rate, the Fed also pointed out that the, “underutilization of labor resources is gradually diminishing.” Moreover, household spending and business fixed investment are advancing, although recovery in the housing market continues to be slow. In terms of price developments, monetary authorities explained that inflation has, “continued to run below the Committee’s longer-run objective,” and projected that inflation will be held down in the short term due to lower energy prices. However, long-term inflation expectations have remained stable and the risk of inflation running persistently below the 2.0% target has diminished.

Meanwhile, in order to support continued progress in the economy, the FOMC confirmed that the federal funds target rate would remain within the current range of between 0.00% and 0.25%. Decisions to hike the rate still depend on the assessment of a, “wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” Moreover, the Fed indicated that it would likely be appropriate to maintain the current low target range for the federal funds rate for, “a considerable time following the end of its asset purchase program this month.”

Analysts have been looking for a more precise indication as to when the Fed might start to hike rates. However, the Fed is avoiding a fixed timeline as it believes the current low rate policy is providing important support for the economy and because it wants to be able to respond flexibly to any potential change in the economic scenario. The Fed stated that, “if incoming information indicates faster progress toward the Committee’s employment and inflation objectives, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.”

Despite the lack of a clear timeframe for a first rate hike, analysts generally see the Fed’s statement as being more optimistic and interpret this as a signal that the Fed is on track to hike rates sometime in the second half of 2015. Economists covering the U.S. at Nomura explain:

“Taken together, the changes to the statement were, in our judgment, more hawkish. They suggest that the FOMC does not see a range of recent developments – including signs of weaker growth abroad, the recent appreciation of the dollar, and recent financial market volatility – as posing substantial risks to the outlook. Moreover, the Committee may be prepared to discount, at least to some degree, the near-term effect on inflation from the recent declines in oil prices. This suggests that the FOMC is on track to begin raising short-term interest rates next year. The changes in today’s statement definitely shift the probabilities, at the margin, towards sooner, rather than later.”

FocusEconomics Consensus Forecast panelists expect the Fed to keep interest rates unchanged in 2014. The vast majority of panelists surveyed expect the Fed will raise interest rates by Q3 2015, with an average of 0.67%. Almost half of the panelists surveyed project that the Fed will raise rates as early as Q2 2015. For the full year 2015, the panel sees the federal funds rate averaging 0.94%.

Author:, Economist

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United States Monetary Policy Chart

USA Monetary Policy October 2014 1

Note: Total assets on the balance sheet of the Federal Reserve in USD billion and Federal Funds Target Rate in %. Current rate set at a range of between 0% and 0.25%.
Source: Federal Reserve

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