Bloomberg

29 January  2014

Fed Raises Assessment on Economy While Staying Patient on Rates

The Federal Reserve boosted its assessment of the economy and played down low inflation while repeating a pledge to stay “patient” on raising interest rates.

The Federal Open Market Committee described the expansion as “solid,” an improvement over the “moderate” performance it saw in December. It substituted “strong” for “solid” in its evaluation of job gains after a meeting Wednesday in Washington.

While inflation “is anticipated to decline further in the near term,” the FOMC said in a statement, it is likely to rise gradually toward its 2 percent goal “over the medium term” as the impact of low oil prices diminishes. Policy makers also said cheaper energy will help boost consumer buying power.

The Fed’s confidence in the outlook for higher inflation and lower unemployment suggests it will stick to plans to raise interest rates this year for the first time since 2006. One caveat: officials will take “international developments” into account when considering an increase, language that contributed to a decline in stocks and Treasury yields.

“The Fed’s decision about the timing of liftoff is not as sensitive to low inflation as before,” said Laura Rosner, a U.S. economist at BNP Paribas SA in New York and a former New York Fed researcher. “Inflation is one of many factors that will be considered in deciding when to raise rates. The inflation undershoot is no longer receiving special emphasis.”

Stocks Decline

The Standard & Poor’s 500 Index slumped 1.4 percent to close at 2,002.16 in New York. The Dow Jones Industrial Average posted its biggest two-day loss in a year as energy shares plunged and concern grew about international risks to the American economy and weakness in multinational earnings.

The 10-year Treasury yield fell to 1.72 percent after earlier dropping as low as 1.70 percent today, the lowest level since May 2013 on a closing basis.

“The Fed is getting concerned about international developments in the context of low inflation, but they’re still upbeat about growth domestically,” said Dominic Konstam, global head of interest-rate research at Deutsche Bank AG in New York.

The last time the FOMC statement made a direct reference to international turbulence was January 2013, when officials warned that “although strains in global financial markets have eased somewhat, the committee continues to see downside risks to the economic outlook.”

Clause Dropped

The Fed also dropped a clause from its December statement that the assurance of patience was consistent with a previous pledge to hold rates low for a “considerable time,” especially if “projected inflation continues to run below” the 2 percent target. The Fed has kept its main interest rate near zero since December 2008.

All 10 voting FOMC members backed Wednesday’s policy statement, marking the first unanimous decision since June.

Robust economic growth is giving Fed officials reason for optimism, even as weaker global demand and a stronger dollar cut into overseas earnings of companies such as Procter & Gamble Co.

Since their last meeting, Fed officials learned that the world’s largest economy grew at a 5 percent annual pace in the third quarter, the most since 2003. A report Friday may show growth of 3.1 percent, still well above the post-recession average of 2.2 percent, a Bloomberg survey of economists shows.

Six-Year Low

Unemployment is at a six-year low of 5.6 percent, and the economy added 252,000 workers last month to cap the biggest annual gain since 1999 with growth of almost 3 million jobs.

Even as the Fed nears its goal of full employment, its second mandate, for stable prices, remains well out of reach.

The Fed’s preferred inflation gauge, personal consumption expenditures, rose 1.2 percent in November from a year earlier and has lingered below the central bank’s 2 percent target for 31 months. Market-based expectations for inflation in the five years starting five years from now tumbled earlier this month to 1.76 percent, the lowest since 1999.

Oil prices at the lowest level since March 2009 signal inflation is likely to remain muted. West Texas Intermediate crude futures for March delivery settled at $44.45 a barrel today after tumbling from $107 in June.

Policy makers put greater emphasis on the tie between lower oil prices and falling inflation, saying price increases “largely” reflect cheaper energy costs. The prior statement said crude’s decline was “partly” the cause.

Economic reports this week indicated that cheap oil is a boon for households and a mixed blessing for companies. The Fed said Wednesday that household spending is rising as “recent declines in energy prices have boosted household purchasing power.”

Consumer Confidence

Consumer confidence soared in January to the highest level in more than seven years as gasoline prices fell, while orders for durable goods unexpectedly dropped for a fourth month, signaling the global slowdown is weighing on manufacturers.

Fed Chair Janet Yellen suggested at her December press conference she’s in no rush to raise rates. She said the reference to being patience means the committee “is unlikely to begin the normalization process for at least the next couple of meetings.”

“The door is open for the first rate hike in June,” said Jim O’Sullivan, chief U.S. economist at High Frequency Economics in Valhalla, New York. “They have seen the unemployment rate come down rapidly and that is probably the most important determinant of future Fed action.”

A cooling global outlook is giving policy makers pause. The International Monetary Fund last week made the steepest cut to its global-growth forecast in three years.

The FOMC gathering is less than a week after the European Central Bank announced an expanded asset-purchase program of up to 60 billion euros ($69 billion) a month to spur growth and counter deflationary pressures, highlighting the diverging prospects for two of the world’s largest economies.

Fed officials “still want to remove accommodation, but it’s a reinforcement the fundamental picture suggests they could be patient in doing so,” said James Sarni, a managing principal at investment manager Payden & Rygel in Los Angeles, with $85 billion in assets. “They acknowledge the weakness on a global basis.”