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Published On: Thu, Sep 18th, 2014

Fed reassures it is sticking to zero rates, but projections point to steeper rate hikes

On Wednesday the Fed assured it is pursuing very low interest-rate policy for “considerable time”, but the new projections give a clue of more aggressive rate hikes to come.

The Fed assured it is pursuing very low interest-rate policy for “considerable time”, but new projections give a clue of more aggressive rate hikes to come.

The Fed  announced once again on Wednesday it was going to keep to its pledge of almost zero interest rates for “considerable time”. But the announcement also contained information on a possible spike in borrowing costs, sooner than anticipated. It was the general expectation of economists and traders that the Fed would change the rate guidance which has been in effect since March, as economic performance data are picking up.

The Fed’s statement, however, assured them interest rates would hover around current levels for some time after the end of the bond-buying program. At the FOMC press conference, the Fed announced another reduction, by $10 billion, in its monthly purchases, which sets the QE to be shuttered on the next policy meeting.

Wednesday’s statement was practically unaltered compared to July’s one, but new quarterly projections were released shedding light on the Fed’s view of future of interest rates, with likelihood of a rate hike; that view diverges from the projections of financial markets. The benchmark overnight rates have been held close to zero since December 2008. The Fed’s  balance sheet has soared over fourfold to $4.4 trillion, via a range of programs for comprehensive-scale bond purchasing. Another indication the Fed is not in a hurry to raise rates is the assessment repeated by FOMC of hefty amounts of slack remaining on the US labor market.

The statement yielded little changes in stocks, but the USD/JPY soared to the highest level since September 2008. Rise to session highs was marked in US treasury bonds yields: traders moved to assess the likelihood of upcoming higher rates.

The new projections were the most meaningful part of the change, suggesting officials were preparing for a potentially faster paced rate hikes than the one they envisioned in June’s forecasts bundle. The median next-year-end projection was 1.375 percent, against June’s 1.125 percent; the end-2016 projection climbed from 2.50 to 2.875 percent. The 2017 median remained 3.75 percent, which is regarded by officials as not stimulating, but not restricting, either. In contrast, Fed funds futures for December 2015 signal a 0.745 percent  interbank lending rate by end-2015. December 2016 contracts are pointing to a 1.85 percent rate.

At a  news conference, Fed Chair Janet Yellen said the shift should not be overestimated. She said it was generally in line with expectations, given the reduction in unemployment and a meager upward change in the inflation projection.

A new item released by the Fed was a new roadmap for exiting the monetary stimulus introduced to tackle the 2007-09 recession. The central bank is planning to withdraw reinvestments of bond holdings proceeds, at some time after rates start to be raised, depending on what state the economy has. Another plan is on moving the overnight federal funds rate target, by altering amounts paid to banks for the holding of excess reserves at the central bank. To support it, the overnight reverse repurchasing agreenments would be introduced.

Before the policy meeting this week, some Fed officials shared the discomfort they felt about the Fed’s rate guidance, as it was linked to a calendar schedule, not comforming to economic progress. According to many economists, it would probably be omitted from the statement after the October meeting.

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