Fed to keep policy normalisation on track
WASHINGTON - A US economy still sending mixed signals on its strength should keep monetary policy locked in place when the Federal Reserve meets Tuesday and Wednesday.
The Federal Open Market Committee meets for the first time with Israeli-American Stanley Fischer, the former head of the Israeli central bank, in his new job as Fed vice chair, with the economy’s rebound from the first quarter contraction still just tentative.
All expectations are for current policy to remain in place: the steady drawdown of the bond-buying stimulus program, and the signals that the near-zero benchmark federal funds interest rate will not be increased before next year.
The FOMC is seen cutting another $10 billion from its stimulus programme, taking it to $35 billion a month, on track to wind up late this year.
But economic projections made by FOMC members could refine the expected timing of the eventual rate increase after the stimulus is ended, the so-called normalization of monetary policy.
That remains a key question as equity markets, awash in liquidity, boom to record highs, while the global economy still sags under the weight of the struggling Chinese, Japanese and European economies.
Planning for the future
"The overall tone of the Fed’s message was little changed between the March and April FOMC meetings, but next week’s post-meeting communications may show emerging signs of change," said economists at Deutsche Bank.
"We think policymakers could drift toward an earlier onset of tightening (Q2 2015), thereby resulting in an additional rate hike next year," they said.
Yet recent US data does not make that a certainty. Activity has picked up since the 1.0 per cent contraction of the first quarter, but the rebound is uneven: stronger job creation but relatively flat wage growth, still-dull consumption and a weakening housing market.
Inflation pressures are subdued and the rate well below the Fed’s 2.0 per cent target.
On the other hand, the Fed also faces a fresh challenge to defend its dovish stance after Bank of England governor Mark Carney suggested Thursday that its benchmark rate could be increased this year.
A rate rise "could happen sooner than markets currently expect," Carney said. That helped push US bond yields up sharply, though they remained well below their highs of last December when there was more confidence in US economic growth this year.
Beyond the new forecasts, the main thing that could come from the policy announcement on Wednesday is more information on how the Fed plans to keep markets calm as it does return to normalized policy.
The FOMC discussed in its last meeting how to manage the challenges of volatility after the stimulus is wound up -- especially, how to prevent market speculation from driving up short-term interest rates to unjustified levels that would stifle economic activity.
"Much of the work that has gone into designing the new framework has focused on ways to build a floor under overnight rates," said analysts at Wrightson ICAP.
"However, as the supply of reserves shrinks, the Fed will at some point need ways to limit the risk of upside volatility in overnight rates as well."