The Outlook: Federal Reserve Bets It Won't Wait Too Long on Rates

By Dow Jones Business News, 
A A A

Federal Reserve Bets It Won't Wait Too Long on Rates -- The Outlook


By Jon Hilsenrath

In a recent Wall Street Journal survey, 30 private economists said they feared the Federal Reserve would wait too long before raising short-term interest rates, while only three said they feared the Fed would move too early.

Will the Fed fall behind the curve and keep interest rates too low for too long as the economy strengthens? The question looms as officials travel this week to their annual gathering in Jackson Hole, Wyo., where they and the world's leading central bankers discuss economic issues.

Fed Chairwoman Janet Yellen and academic papers presented at the meeting will focus on labor markets, which are improving rapidly even though U.S. economic growth has been sluggish and erratic. Ms. Yellen seems likely to acknowledge the improving job market, though she has argued for much of the year that slack and headwinds endure after the 2008-09 financial crisis.

A growing number of economists believe slack in labor markets is diminishing, making the economy prone to inflation and financial markets prone to overshooting with short-term interest rates near zero. The unemployment rate fell to 6.2% in July from 7.3% a year ago, a decline far faster than Fed officials expected.

"They are making me nervous," Arun Raha, the chief global economist for Cleveland-based Eaton Corp., an industrial manufacturer, said of Fed officials. "Given the strength of the job market, manufacturing and nonresidential construction, it's about time they got rid of their low-rates-for-an-extended-period viewpoint."

A handful of Fed officials are sympathetic to this view. "The idea that the Fed might get behind the curve is a powerful one, and that's certainly been the history of the institution. People are right to worry about that," James Bullard, president of the Federal Reserve Bank of St. Louis, said in an interview with the Journal last week.

Fed forecasts show most officials expect to start raising rates next year. Many market participants see mid-2015 as the starting point. The Fed's move is especially important because many of the world's other central banks follow its lead. If Ms. Yellen waits, other central banks will have an incentive to wait, too.

Top Fed officials believe they can be patient before starting to raise short-term rates. Among the reasons why: Whether they look at financial markets or the broader economy, the actual prices people pay for Treasury bonds, workers' wages or the costs of day-to-day consumer goods aren't signaling an economy near overheating.

Yields on 10-year Treasury notes fell Friday to a 14-month low of 2.345%, down from more than 3% at the beginning of the year. Investors sell bonds, pushing up their yields, when they fear inflation or lose faith in the Fed. Many market analysts expected yields to go up this year as the Fed wound down an $85 billion-a-month bond-buying stimulus program. Instead yields are falling, as investors turn to U.S. Treasurys as a haven amid turmoil overseas. If investors have lost confidence in the Fed, the Treasury market isn't showing it.

Hourly earnings of private-sector workers were up 2% in July from a year earlier. In theory, as the jobless rate falls, shortages of available workers should push up wages and inflation pressures. There is no ironclad rule for how low unemployment can fall before these pressures emerge. Fed officials have theories; most of them see pressure building when the jobless rate reaches 5.2% to 5.5%, a zone it is on track to reach by March of next year. Without hard proof, however, they are looking especially carefully for evidence in the form of wages, like steam coming from a teapot. And so far they're seeing little steam.

The Fed's preferred measure of consumer inflation--the Commerce Department's personal consumption expenditures price index--was up 1.6% in June from a year earlier, its 26th straight month below the Fed's 2% objective. The Labor Department's more widely followed consumer-price index has touched 2% but after running below it for most of 2012 and 2013. Yes, food prices are way up, but other areas aren't. Gasoline, for example, is cheaper today than it was in 2008 or 2010. Moreover, inflation isn't as volatile as it was in the 1970s and 1980s. That could buy the Fed time when the moment arrives to tighten the financial system's screws.

Atlanta Fed President Dennis Lockhart has said he prefers a "whites of their eyes" approach to monetary policy, holding off on rate moves until he is sure the economy is on strong footing. The Fed has pulled back bond-buying programs before, only to restart them when the economy disappointed.

Allen Sinai, president of Decision Economics, an economic-forecasting firm, says the Fed is more effective when it acts pre-emptively. If inflation pressures emerge with a jobless rate at 5.5% or lower, does the central bank want its interest rates at zero when that moment arrives?

"You don't throw a football at a person. You throw it in front of the person because the person is moving," he said.

Mr. Raha, of Eaton Corp., says the central bank should start moving away from its assurances of low rates by deleting a line in its policy statement saying interest rates will stay near zero for a "considerable time" after the bond purchases end in October.

While they haven't changed that phrase, Fed officials have made some subtle shifts. Ms. Yellen in July testimony to Congress said that if the economy continues to improve more quickly than expected, the central bank will raise rates sooner than expected. That means earlier than mid-2015 is possible.

Still, she and other top Fed officials believe they have been served well keeping the money spigots open in an economy that keeps disappointing. They will need some more proof before they heed the warnings of those who say they're falling behind the curve.

Pedro Nicolaci da Costa contributed to this article.

Write to Jon Hilsenrath at jon.hilsenrath@wsj.com


  (END) Dow Jones Newswires
  08-17-142035ET
  Copyright (c) 2014 Dow Jones & Company, Inc.


This article appears in: US Markets , Economy , International

Referenced Stocks: ETN

Dow Jones Business News


More from Dow Jones Business News:

Related Videos

Stocks

Referenced

67%

Most Active by Volume

91,252,153
  • $13.78 ▼ 4.31%
68,133,496
  • $12.93 ▲ 6.77%
57,268,074
  • $46.13 ▲ 2.47%
43,432,023
  • $105.22 ▲ 0.37%
40,880,685
  • $13.46 ▲ 8.90%
40,712,405
  • $98.62 ▲ 0.82%
39,776,976
  • $16.72 ▲ 0.72%
34,688,871
  • $11.16 ▲ 3.05%
As of 10/24/2014, 04:15 PM