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Economic Update

 
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New Fed chair introduces new forward guidance

March 19, 2014

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The Federal Open Market Committee (FOMC) concluded its two-day meeting on Wednesday with a further reduction of asset purchases.  Consistent with expectations, the Fed replaced numerical thresholds with qualitative forward guidance.  Minneapolis Fed President Kocherlakota cast the lone dissenting vote.  He believes that the qualitative forward guidance reduces the Fed’s credibility about its inflation commitment to "return inflation to the 2.0% target from below and fosters policy uncertainty." 

Key points from today’s decision:

  1. The FOMC reduced monthly purchases of securities by $10 billion, putting the total at $55 billion.  The Fed has now reduced asset purchases by a third since December 2013. 
  2. The post-meeting statement included the following forward guidance:  “In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress--both realized and expected--toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” 

    Gone was the reference to a 6.5% unemployment threshold, which has come up on the horizon much more rapidly than many expected.  While the unemployment rate is the single best indicator of labor market performance, recent developments highlighted its weaknesses. In this context, the Fed’s change of communication makes sense.
  3. Although many FOMC participants anticipate a 2015 hike in the federal funds rate, new language included in today’s statement notes that the Committee expects economic conditions may warrant keeping the federal funds rate below a normal long-term level even after inflation and employment are "near-mandate consistent levels."  These two aspects suggest that the Fed will take a measured and cautious path when it commences tightening.
  4. The Fed modestly trimmed the outlook for economic growth it published last December.  Real gross domestic product is projected to grow between 2.8% and 3.0% in 2014; the downward adjustment is due partly to the impact of poor weather on first quarter results.
  5. The unemployment rate is projected to decline to 6.2% by the end of 2014.  In remarks following the meeting, Fed Chair Yellen stressed that employment is best understood by a broad set of indicators, and she added that this broader collection shows considerable slack in the labor markets.

Janet Yellen did a nice job handling the press conference following the meeting.  We’ll reflect more deeply on the new regimes of Fed leadership and forward guidance in this week’s Friday commentary.

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The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The Northern Trust Company does not warrant the accuracy or completeness of information contained herein, such information is subject to change and is not intended to influence your investment decisions.
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