Policy turn? After years of aggressive monetary stimulus, Fed could hint on rate-hike

Washington: The US Federal Reserve on Wednesday could offer fresh clues on when it plans to begin lifting interest rates and how quickly it will move, as it prepares for a momentous policy turn after years of aggressive monetary stimulus.

Although a tightening of monetary policy is not expected until mid-2015, the central bank could use a policy statement on Wednesday to lay important groundwork.

In particular, speculation is rife the policy-setting Federal Open Market Committee may change its guidance on how long it is likely to keep rates near zero. The panel may also alter its depiction of the labor market to suggest further progress toward its goal of full employment.

Both would signal that a six-year freeze on rates is thawing. Although the market is betting on a policy change, the Fed could also stick to its script.

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Along with the policy statement it will issue at 2 p.m. (1800 GMT), the Fed will lay out new economic and interest rate projections that will extend out to 2017 for the first time. The rate projections - or “dots chart” - show where individual Fed officials think rates should be at the end of each year.

Some economists think a spate of mostly good news on the economy could spur officials to hint at a more aggressive rate-hike path, which would widen the distance between their views and those held in the bond market.

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“The committee’s median projection for interest rates at the end of 2015 and 2016 could be pushed up a bit as they were in June, providing a hawkish signal to markets,” economists at IHS Global Insight said in a note earlier this month.

But because the individual forecasts are not labeled, and some policymakers, such as Chair Janet Yellen, deserve more weight than others, “it will be difficult to separate the signal from the noise,” the economists warned.

It will be up to Yellen, who holds a news conference a half hour after the statement and projections are released, to clarify the Fed’s policy intentions.

EYES ON THE LABOR MARKET

The path to a rate increase is hugely important for investors. In June, the median of the Fed’s projections suggested rates would reach 1.125 percent by the end of next year, more than a quarter point higher than futures markets have priced in.

The Fed also needs to decide whether to maintain a pledge to keep near-zero rates in place for a “considerable time” after its bond-buying stimulus program ends. With the central bank set to reduce its monthly purchases to $15 billion this month, the program will likely end in October.

A number of officials have said they are uncomfortable with an assurance that is based on the calendar and not the economy’s progress.

“If that language isn’t softened at this meeting, then it will surely be weakened at October’s meeting,” economists at Capital Economic said a research note on Tuesday.

Another phrase some economists think could come under the knife is the Fed’s description of slackness in the labor market as “significant,” although they appear to be in the minority.

While the unemployment rate dipped back down to 6.1 percent in August, job growth slowed and wage gains remained sluggish, factors that are likely to bolster Yellen’s resolve not to move too hastily in tightening policy.

Reuters