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Fed pegs rate hike to unemployment

By Sheyna Steiner · Bankrate.com
Wednesday, December 12, 2012
Posted: 1 pm ET

At the final meeting of 2012, the interest rate-setting group at the Federal Reserve resolved to leave the federal funds rate targeted between zero percent and 0.25 percent, marking nearly four years since the benchmark rate was first dropped to the lowest point ever Dec. 16, 2008.

With a nod to economic uncertainty, including the "fiscal cliff," the Federal Open Market Committee expanded the stimulus program known as QE3. The central bank will let the maturity extension program, Operation Twist, expire on schedule at the end of the year but will keep dancing to the tune of $45 billion in outright Treasury purchases every month.Ben Bernanke

Under Operation Twist, the Federal Reserve sold short-term Treasury securities it already owned and bought longer-term securities in their place. Since the program was extended in June, the Fed has bought and sold about $44.5 billion worth of Treasuries per month.

The central bank said Wednesday that it will continue buying longer-term Treasury securities in addition to $40 billion of mortgage-backed securities every month. The Fed committed to buying the mortgage-backed securities in September, when it began its third round of quantitative easing, known as QE3.

The purchasing programs are open-ended, which means the Fed will continue to buy assets until the economy improves sufficiently.

The central bank also changed their forward guidance on interest rate policies. Rather than hewing to the calendar-based forecast for when interest rates could rise, today's statement revealed unemployment and inflation thresholds that the Fed will look for before a rate increase is considered:

In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

This view is in line with the date-based guidance, which forecast a rate increase in 2015, the statement says.

Different meeting, same outcome for consumers

One of the Fed's stated aims with the asset purchase plans is to keep interest rates down on the long side of the yield curve. Purchasing Treasury securities outright, rather than swapping short maturities for long, may amplify that effect because it will reduce the overall amount of Treasuries in the market.

"My view is that you would see interest rates fall further," says Scott Kimball, portfolio manager of the BMO TCH Corporate Income Fund.

With "a slowing economy and the reduction in the supply (of Treasuries), you could also see the yield curve change," he says. "The rate that would move the most at the onset would be the 10-year declining more than the 30-year, so you get the steepening yield curve. Mortgage rates, anything linked to the 10-year Treasury, could theoretically see more of a decline."

Of course, mortgage rates have been a specific target of Federal Reserve policies. In order to goose the housing market, mortgage rates have been pushed to increasingly low levels in order to make homebuying and refinancing more affordable.

"It seems to have done that, at least in small part," says John Stewart, managing director of Vantage Economics, an economics consulting firm. As a result of Fed policies, mortgage rates are at historic lows.

Other types of loans are at unprecedented depths. Auto loan rates, for instance, have never been lower and credit card rates, which are more directly influenced by the Federal Reserve, are about as low as they can get, according to Bankrate's weekly interest rate surveys.

Unfortunately, it's not all shopping sprees and new cars, particularly for those on a fixed income. Savers will continue to suffer with ever-lower rates on savings vehicles such as savings accounts, money market accounts and CDs.

Shifting transparency

The change to the forward guidance is a major step toward greater clarity and transparency on interest rates. Previous guidance indicated that a rate increase would come in 2015, but the economic conditions the central bank would like to see were a mystery.

"From a practical sense, that is in some ways a ridiculous statement to make. It's just not very helpful and the precision around that is almost meaningless," says Alan Gayle, senior investment strategist for RidgeWorth Investments in Atlanta.

With Wednesday's announcement that the Fed will be targeting an unemployment rate at or below 6.5 percent and long-term inflation expectations running over half a percent above the central bank's 2 percent target, "we get some clarity on the nuance about what the Fed is looking for in order to change policy going forward," Gayle says.

Fed-watchers can look forward to more information about the central bank's groundbreaking communications strategy at a future at the press conference Wednesday afternoon with Federal Reserve Chairman Ben Bernanke.

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4 Comments
Jim R.
December 13, 2012 at 6:17 pm

The loss to the treasury from lower income taxes on near zero interest rates has got to be staggering. I know of retirees who have dropped off the roles and pay no taxes now. They have less to spend. A double sword against our economy.

gorgeous george
December 12, 2012 at 8:17 pm

we would not need all this twisting and tweaking if people paid the correct tax. all the tax fraud and gov. rip off scams by our own federal officials and gov. contractors. and a fair tax system would eliminate the deficits and give us a roaring economy worldwide. but, for some reason the rich want allow it and the warmongers.