WASHINGTON – Investors will be watching closely Wednesday for any hints of how a Janet Yellen-led Federal Reserve might differ from the path set by her predecessor, Ben Bernanke.
The Yellen era will begin in earnest when the Fed ends two days of policy discussions. It will be her first meeting as Fed chair, a position she assumed Feb. 3, after Bernanke stepped down after eight high-profile years.
After the Fed issues a statement at the end of its policy meeting and updates its economic forecasts, Yellen will preside over a news conference. She is widely expected to embrace Bernanke’s approach of keeping interest rates low while gradually paring the Fed’s economic stimulus.
Most analysts expect the Fed to announce a third reduction in the monthly pace of its bond purchases from $65 billion to $55 billion. Those reductions are expected to continue this year until the bond purchases end altogether by December.
The Fed’s bond purchases have been intended to keep long-term borrowing rates low to spur spending and growth. Its decision to continue paring them signals its belief that the economy is showing consistent improvement.
Many analysts think the Fed could make one change in its statement Wednesday. It may drop a reference to a specific unemployment rate that might cause it eventually to begin raising short-term rates.
The Fed’s most recent policy statement said it planned to keep short-term rates at record lows “well past” the time the unemployment rate fell below 6.5 per cent. The rate is now 6.7 per cent. Several Fed officials have recently suggested scrapping the 6.5 per cent threshold and instead describing more general changes in the job market and inflation that might trigger a rate increase.
One reason for dropping the threshold, as Yellen among others have noted, is that the unemployment rate can overstate the job market’s health. In recent months, for example, the rate has fallen not so much because of robust hiring but because many people without a job have stopped looking for one. Once people stop looking for a job, they’re no longer counted as unemployed, and the rate can fall as a result.
“There is a growing consensus to go with more nuance instead of a specific number,” said Diane Swonk, chief economist at Mesirow Financial. “I think they are just too close to 6.5 per cent on the unemployment rate.”
Yellen has spoken of seeking continuity with Bernanke, under whom she served as vice chair. That is one reason markets expect a further pullback in bond purchases.
If the gradual reductions were halted, it could raise concerns that the Fed has begun to worry about challenges the economy is facing, from a brutal winter that’s depressed growth to fears about how Russia’s aggression toward Ukraine might slow the global economy.
Fed officials, including Yellen, have signalled their belief that the weakness in U.S. economic data is temporary rather than a sign that the economy is losing momentum.
The Fed and most private economists foresee faster economic growth later this year. Many think the economy, which grew a lacklustre 1.9 per cent in 2013, will rebound to around 3 per cent this year.
“We had a tough start to the year with the winter storms, but it looks like we are starting to pull out of those weather effects,” said David Jones, chief economist at DMJ Advisors.
Economists point to several hopeful signs — from a rebound in retail sales to an increase of 175,000 jobs in February despite continued harsh weather.
Even if the economy strengthens and the Fed ends its bond purchases late this year, it will still be stimulating the economy. It has no plans to start selling its enormous portfolio of bonds — a step that would likely send loan rates up. Nor is it likely this year to raise the benchmark short-term rate it controls.
More than five years ago, the Fed cut that rate to a record low near zero, where it’s remained since. Most analysts think the Fed will keep its target for short-term rates near zero until late 2015.
Not all economists expect the Fed this week to drop a link between a specific unemployment rate and an eventual rate increase.
“I don’t think they will tweak the language,” said Brian Bethune, an economics professor at Tuft University. “There is enough wiggle room currently.”