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Fed unlikely to redraw markers for rate hike

"SAN FRANCISCO/NEW YORK (Reuters) - Federal Reserve policymakers have cooled to the idea of explicitly raising the bar on future interest rate hikes, a sign the U.S. central bank is angling for a return to more subtle -- and familiar -- ways of explaining how it plans to steer the economy.

The Fed, still struggling to boost the U.S. recovery from the Great Recession, remains intent on assuring investors that easy monetary policy is here for the long haul. Households and businesses, in the Fed's view, need low borrowing costs to get spending and investment back on a self-sustaining path.

That's the reason the central bank took the unprecedented step last December of pledging to keep overnight interest rates near zero until unemployment falls to at least 6.5 percent, unless inflation threatens to rise above 2.5 percent.

By providing economic guideposts, or thresholds, the Fed hoped to convince investors it was serious about keeping overnight rates low. To the degree investors were convinced, the long-term borrowing costs markets set would stay low as well, since they embody expectations for future overnight rates.

But earlier this year, when Fed Chairman Ben Bernanke hinted the central bank could soon reduce its bond purchases - the other tool it has been using to hold down long-term rates - bond yields, which act as a benchmark for many borrowing rates, spiked, sparking a debate over whether the forward guidance on interest rates needed to be strengthened.

Last month, two highly publicized Fed research papers suggested that lowering the unemployment rate threshold could give the economy additional thrust, fueling a surge of speculation that such a plan was in the offing. Bernanke, after all, had earlier suggested it was a possibility.

But Fed officials appear to be leaning against such a move and have already moved back to the tried-and-true approach of letting a few well-chosen phrases guide market expectations.

Minutes from the Fed's last policy meeting show only two officials backed a lower unemployment threshold -- and one of them has since tamped down the idea. Meanwhile, remarks from Bernanke and Fed Vice Chair Janet Yellen suggest they have abandoned the notion.

Yellen, the nominee to succeed Bernanke as Fed chairman when his term expires January 31 and who has spearheaded the evolution of the Fed's post-recession communications strategy, said policy was likely to stay loose "long after" one of the thresholds has been crossed. "It is also important to note that the thresholds are not triggers," she said last month.

Bernanke similarly noted that rates could stay at rock bottom "well after" the 6.5 percent unemployment threshold was crossed. The jobless rate stood at 7.3 percent in October.

QUALITATIVE MESSAGES

Unlike the last time markets began seriously expecting a reduction to the Fed's bond buying, back in September, investors now appear convinced that interest rates won't start to move up for at least another year and a half.

"I think that the message that 6.5 (percent) is a threshold not a trigger and that rates will remain low even after that level is breached has sunk into market participants, so there is little benefit to changing the threshold," said Tim Duy, an economics professor at the University of Oregon.

Indeed, minutes from the Fed's October 29-30 policy-setting meeting suggest that aside from Charles Evans, president of the Chicago Federal Reserve Bank, and Minneapolis Fed chief Narayana Kocherlakota, there is little enthusiasm for reducing the unemployment threshold.

Even Evans, the original architect of threshold-based policy, has pulled back a bit.

Asked earlier last month if he would support Kocherlakota's idea to promise low rates until unemployment falls to 5.5 percent, a level many economists believe is consistent with a healthy economy, Evans said he would.

He added: "I would guess that that's a very aggressive action and perhaps only a more intermediate step would be called for."

James Bullard, the St. Louis Fed president, who has called for adding a pledge to keep rates low as long inflation lingers below a certain floor, has a "few" like-minded thinkers among his colleagues, the Fed minutes show.

But Bullard acknowledged that it was more likely the Fed would "describe how we will behave after we pass the 6.5 percent threshold" rather than tweak the threshold itself.

That kind of qualitative description "is the way they will go for now," said Eaton Vance portfolio manager Eric Stein. "The unemployment threshold and in particular raising the inflation target are probably too controversial to do right now although they could happen in the future."

Not everyone agrees.

Carl Tannenbaum, a former Fed official who is now chief economist at Northern Trust, "absolutely" believes the Fed will lower the 6.5 percent unemployment threshold, given the necessity to keep long-term borrowing costs tamped down.

"It's a way of keeping long-term rates from going too crazy," he said. "They need to stay easy. ... We've got really low inflation in this country."

Policymakers, however, might have a hard time making the case that fresh thresholds will not simply be updated again and again. It "might cause us to lose credibility for the whole endeavor of having thresholds," Bullard said.

They "are not to be abrogated lightly," he told reporters on Nov 21. "If we move them around then markets would start to wonder whether we'll move them again if data suggested we didn't have the right number that was convenient at that point in time."

http://finance.yahoo.com/news/fed-unlikely-redraw-markers-rate-061645391.html

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