United States Monetary Policy

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United States: Fed asset purchase program nears completion, still no clear timeline for interest rate hike

September 26, 2014

The Federal Reserve’s asset purchase program is nearing its end. Completion of the program will mark an important milestone in the government’s management of the economic crisis and will likely boost confidence in the markets. At its 16–17 September policy meeting, the Fed’s Federal Open Market Committee (FOMC) announced, “a further measured reduction in the pace of its asset purchases.” Starting in October, the Fed will conduct purchases of USD 10 billion in long-term Treasury securities and USD 5 billion in mortgage-backed securities per month, which is down from USD 15 billion and USD 10 billion respectively. The Fed’s decision comes as the result of, “cumulative progress towards maximum employment and the improvement in the outlook for labor conditions.” The amount of monthly purchases has been tapered substantially during the year and the purchase program will end at the following meeting. However, the Fed’s balance sheet has reached a record USD 4.4 trillion and many questions are emerging about how to manage the accumulated assets.

According to the Fed, economic growth continues to expand at a moderate pace. The Fed also pointed out that labor market conditions have improved, but that the unemployment rate is broadly stable and a mix of indicators point to “ongoing underutilization of labor resources.” Moreover, while household spending is rising moderately and business fixed investment has advanced, recovery in the housing market continues to be slow. In terms of price developments, monetary authorities explained that inflation, “has been running below the Committee’s longer-run objective,” while adding that long-term inflation expectations have remained stable. The Fed also recognized that 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 announced 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 after the purchase program ends.” Some analysts had expected that the Fed would signal that a rate hike is in the near future by removing the “considerable time” reference. However, the Fed is being cautious about changing course prematurely as it believes the current low rate policy is still providing important support for the economy. In a statement after the meeting, Fed Chair Janet Yellen said that they would continue to monitor economic developments and that any decision to hike rates will be “data dependent”.

There is ongoing debate within the Fed over when to raise interest rates. Charles Plosser was joined by Richard Fisher this month in dissent with the FOMC’s decision to keep rates low for an extended period of time. Their argument against the Fed’s guidance is that, “such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee's goals.” Despite the internal debate about timing and technicalities, the committee does seem set for a faster-than-expected rate hike to be implemented next year. The median projection made by committee members in a supplementary document released after the meeting is for rates to reach 1.375% by the end of 2015, which is up from the 1.125% median projection made in June. The median projection is for rates to close 2016 at 2.875%, up from the previous 2.5%. Nikolaus Keis, Vice President and Economist at UniCredit Research, stated:

“The Fed is getting closer to its first rate hike. The FOMC left its statement unchanged, but the higher rate projections speak volumes. Barring any major downside surprises on the data front, the Fed seems to be on track to start raising the funds rate in the middle of next year.”

While other analysts believe that it is difficult to assess the higher rate projections, and Yellen consistently downplays their significance, the Fed is poised for a rate hike in 2015. In fact, the Fed released an updated version of a blueprint with technical details about how it will normalize monetary policy and manage its balance sheet. At this point, all that is missing is a clear indication of when exactly during 2015 this will be set in motion.

FocusEconomics Consensus Forecast panelists expect the Fed to keep interest rates unchanged in 2014. Next year, the panel sees the federal funds rate averaging 0.74%.

Author:, Economist

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United States Monetary Policy Chart

USA Monetary Policy September 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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