The Wall Street Journal

26 January  2012

Fed Sees Low Rates to 2014

Central Bank Releases Policy Forecasts for Key Benchmark, Targets 2% Inflation

Federal Reserve officials said they expect to keep short-term interest rates near zero for almost three more years and signaled they could restart a controversial bond-buying program in yet another campaign to rev up the disappointing economic recovery.

The central bank’s pronouncements came after a two-day policy meeting from which officials emerged still frustrated at the slow pace of growth and a bit more confident that inflation is settling down after climbing last year. The combination of persistent slow growth and low inflation, Fed Chairman Ben Bernanke signaled in a news conference after the meeting, could give the Fed leeway to take more action to support the economy, though he didn’t commit to it.

Officials hope that by signaling their intentions on short-term interest rates, long-term rates will fall, spurring investment, spending and growth. Since August, the Fed had been saying rates would stay near zero at least until mid-2013.

A bond-buying program—also meant to push down long-term interest rates—could be the next step. Mr. Bernanke said there would be a “very strong case” for even more action by the Fed “if the recovery continues to be modest and progress on unemployment very slow and inflation appears to be likely to be below target for a number of years out.”

The stock market reversed morning losses after the Fed announcement and finished the day higher, with the Dow Jones Industrial Average rising 81.21 points, or 0.64%, to 12756.96. Investors also scooped up Treasury securities. Yields on 10-year Treasury notes, which move down when their prices rise, fell 0.053 percentage point to 2.009%. The dollar rose against the yen but fell against the euro.

The latest meeting was another exercise in Mr. Bernanke’s experimental style as Fed chief. Since the financial crisis in 2007 he has rolled out a stream of unconventional programs to calm unruly markets and spur growth.

This time, Mr. Bernanke pushed the Fed toward a new communications strategy. In detailed tables, the central bank documented for the first time the range of views inside the Fed about when rates—now near zero—might start rising.

Eleven of 17 officials said they didn’t see rate increases until 2014 or later, while six said rate increases should come this year or next. Eleven see the federal-funds rate, an overnight bank lending rate that the central bank controls, at 1% or less by the end of 2014.

Jeffrey Lacker, president of the Richmond, Va., Fed, dissented from the decision to say rates would likely stay low through 2014; he didn’t want the Fed to formally mark that date in its policy statement.

The Fed also took a step Mr. Bernanke has sought since taking the helm of the Fed in 2006: It formally declared the Fed wants inflation of 2% a year in the long run. The goal is to assure the public the Fed won’t let inflation either rise or fall too much. Strikingly though, in the news conference, Mr. Bernanke suggested he might let inflation run a bit above that for a little while if it would help to get the unemployment rate, now at 8.5%, lower.

“We’re not absolutist,” he said. “If there’s a need to let inflation return a little more slowly to target to get a better result on employment, then that’s something that we’d be willing to do.”

The Fed’s potentially aggressive stance was notable in part because the economy has shown signs of improving in recent months. The unemployment rate has fallen to 8.5% from 9.1% in August. But the Fed said in a postmeeting statement that it was worried about “strains in global financial markets” and noted that unemployment was still elevated and business investment has been slowing.

Fed officials have become a bit more pessimistic about economic growth, estimating that gross domestic product will expand between 2.2% and 2.7% this year, down from a previous forecast of 2.5% to 2.9%. The 2013 growth projection also was marked down. Fed officials warned that the recovery faces significant risks.

An assurance that rates will stay low might encourage companies such as Composite Horizons Inc., a parts supplier to the aerospace industry.

The company has been making capital investments for the past few years to be ready when the aerospace business picks up. But getting consent from the Composite Horizons board can be difficult given uncertainty about the economy, said the company’s president, Jeffrey Hynes. Knowing the likely path of interest rates will help reduce the variables he has to weigh when proposing a capital investment, he said.

“We have invested in capital and facilities and we are frankly ready to do more,” Mr. Hynes said. He needs to have a 20% rate of return on investments and knowing how much the company will have to pay for interest will help persuade his directors that the returns are possible, he said.

Other businesses see the Fed’s assurances on low interest rates as a double-edged sword. Noah Wilcox, chief executive of Grand Rapids State Bank, in Minnesota, said the Fed move could spur his bank, which has $230 million in assets, to make longer-term loans available to customers. It also means his cost of funds is low.

But he sees drawbacks. Most notably: “If you’re elderly and you’ve scrimped and saved your whole life and you have money tied up in CDs, you’ve been gut shot,” he said. “It is harmful to the seniors in our country potentially, in terms of the real rate of savings.” He added that his bank isn’t earning much on the loans it is making, so its profit margins aren’t any better with the Fed’s promises of low interest rates.

Christopher Klein, chief executive of Fortune Brands Home & Security Inc., a Deerfield, Ill.-based maker of such household products as Moen faucets and Master locks, said he found the Fed forecast helpful.

“We’ll compile it in with the other data available to us” in assessing such things as the affordability of homes, raw material costs and consumer confidence, Mr. Klein said. “For a long time, people tried to read the tea leaves” to understand Fed thinking. “The more candid they can be the better.”

He declined to say whether the Fed release would lead to any changes in the company’s outlook or strategy.

The lower long-term interest rates that the Fed is trying to engineer have already helped people such as Greg Fehn, a 71-year-old retired chemist living in Mundelein, Ill. He has refinanced the $411,000 mortgage on his lakeside home twice in the past 13 months, and expects to close on a third refinancing, at a rock-bottom rate of 2.5%, in about three weeks.

His new loan, which is a five-year adjustable-rate mortgage, will save him $80 a month in payments, and keep him from having to draw more than the minimum annual distribution from his individual retirement account to pay for daily living expenses.

“I keep thinking, this is the last time I’ll have to sign my name a hundred times and close a loan. But lo and behold, rates keep coming down, so I keep doing this,” Mr. Fehn said.

Still, millions of homeowners can’t refinance because their credit has been damaged by the crisis or their homes have lost so much value, a worry that Mr. Bernanke highlighted in his news conference.

The Fed is far from unanimous about making the latest assurance that rates will stay near zero through most of 2014.

The central bank has been remarkably divided about many of the steps it has taken in recent years. The latest projections show that six officials believe rates should rise in 2012 or 2013. Four see short-term rates at 2.5% or higher by late 2014. They are in the minority for now, but Mr. Bernanke acknowledged that circumstances could change the consensus at the Fed.

“Our ability to forecast three and four years out is obviously very limited,” Mr. Bernanke said. “It’s certainly possible that we will be either too optimistic or too pessimistic.”