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Fed Raises Projections for Rates in 2015, 2016

Federal Reserve Officials Continue to Taper Bond Purchases

Jon Hilsenrath

June 18, 2014

Federal Reserve officials nudged up their projections for short-term interest rates in 2015 and 2016 but slightly reduced their outlook for interest rates in the longer-run.

The shifts emerged from the Fed’s latest two-day policy meeting. In a statement released after the meeting, the Fed underlined an improving economic performance in the past few weeks and said it would wind down its monthly purchases of mortgage and Treasury bonds by another $10 billion starting in July, to $35 billion.

Economic activity rebounded since officials last met in April, the Fed said in its official policy statement.

“Labor market indicators generally showed further improvement,” the Fed said on an optimistic note. “The unemployment rate, though lower, remains elevated.” Officials also pointed to a recent resumption of business investment after a slowdown earlier this year as one source of an improved economic environment.

That tint of optimism follows a dismal first quarter in which the economy contracted, forcing officials to reduce their projection for economic growth this year. Officials now see the economy expanding at a 2.2% rate in 2014, substantially slower than a projected growth rate of near 3% offered last March. Still, the Fed maintained its optimism about a pickup in 2015 and 2016.

Fed Chairwoman Janet Yellen, at a news conference after the Fed meeting, said there are “many good reasons” to expect faster growth in 2015 and 2016, including an improving labor market, the Fed’s easy-credit policies, reduced household-debt burdens, rising stock and home prices, and an improving global economy. She said she also expects consumer spending to pick up in part because of rising wages.

The Fed’s interest rate forecasts are likely to draw substantial attention among investors.

On average, Fed officials projected the benchmark federal funds rate would hit 1.2% by the end of 2015 and 2.5% by the end of 2016, up from averages of 1.125% in 2015 and 2.4% in 2016 when the Fed last projected rates in March. Over the longer run, officials on average said the target interest rate could settle in at a lower-than-normal 3.75%, down from earlier forecasts of 4%.

Taken together, the Fed’s new interest rate forecasts imply slightly more aggressive credit tightening plans taking shape in the next two years than previously thought, but less aggressive beyond 2016. Still, the shift in forecasts can be skewed by changes in the composition of the Fed’s policy-making committee since the last forecast round in March. Two officials have left and three new officials have joined.

Ms. Yellen warned financial market participants not to become overly confident the central bank’s ultra-easy monetary policy will exist forever. It is important “for market participants to recognize that there is uncertainty about what the path of interest rates, short-term rates, will be, and that’s necessary because there’s uncertainty about what the path of the economy will be,” she said.

The Fed “will adjust policy to what it actually sees unfolding in the economy over time, and that necessarily gives rise to a certain level of uncertainty about what the path of rates will be, and it is important for market participants to factor that into their decision-making.”

She added, “There is no mechanical formula” for when the Fed will start raising rates.

The Fed’s new interest rate forecasts arise against a shifting economic backdrop. Officials in their projections for the years ahead see the jobless rate falling more than previously thought.

They see the jobless rate receding to 6% or 6.1% by year-end and then to the mid-5% range in 2015 and low-5% range in 2016. Those represented downward revisions from March and suggest the Fed sees less slack in the economy than previously thought, which could help explain the slightly higher near-run interest rate projections.

At the same time, however, the Fed is a little less optimistic about the outlook for economic growth. Officials said the economy’s growth potential might be as low as 2.1% in the long-run, the latest in a string of downward revisions made in recent years. That gloomier long-run growth outlook could help explain why the central bank is producing a lower long-run interest rate forecast of 3.75%.

Ms. Yellen said Fed officials had various reasons for lowering their estimates of long-run growth, but many have cited the “residual effects of the financial crisis,” including lower consumer spending and reduced credit availability.

On inflation, Ms. Yellen said recent data have been “a bit on the high side,” but generally provide evidence that price levels are moving back toward the Fed’s 2% target.

“I think it’s important to remember that, broadly speaking, inflation is evolving in line with the committee’s expectations. The committee has expected a gradual return in inflation toward its 2% objective, and I think the recent evidence that we’ve seen—abstracting from the noise—suggests that we are moving back gradually, over time, toward our 2% objective,” she said.

When asked whether the Fed would allow inflation to rise above 2% for a while, as advocated by some economists, Ms. Yellen said it “would not willingly see a prolonged period in which inflation persistently runs below our objective or above our objective.”

Ms. Yellen also said Fed officials are still working out the mechanics of how they will raise short-term interest rates in the future. “We’ve made quite a lot of progress in our discussion, but we’ve not yet reached conclusions” about the exact mix of tools that will be put into play to help raise interest rates when the time comes, she said.

No officials dissented at the meeting. It was the second straight policy meeting this year for Ms. Yellen in which there was no dissent.

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