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  1. US Fed leaves key rates unchanged says, global volatility may ‘restrain economic activity’

US Fed leaves key rates unchanged says, global volatility may ‘restrain economic activity’

The U.S. Federal Reserve kept interest rates unchanged on Thursday in a bow to worries about the global economy, financial market volatility and sluggish inflation at home, but left open the possibility of a modest policy tightening later this year.

By: | Washington | Updated: September 18, 2015 12:31 PM
US Fed rate hike deferred

Federal Reserve Chair Janet Yellen holds a news conference following the Federal Open Market Committee meeting in Washington September 17, 2015. (Reuters)

The US Federal Reserve kept interest rates unchanged on Thursday in a bow to worries about the global economy, financial market volatility and sluggish inflation at home, but left open the possibility of a modest policy tightening later this year.

In what amounted to a tactical retreat, Fed Chair Janet Yellen said developments in a tightly linked global economy had in effect forced the U.S. central bank’s hand.

“The outlook abroad appears to have become less certain,” Yellen told a news conference after the Fed’s policy-setting committee released a statement following a two-day meeting.

She added that a recent fall in U.S. stock prices and a rise in the value of the dollar already were tightening financial market conditions, which could slow U.S. economic growth regardless of what the Fed does.

“In light of the heightened uncertainty abroad … the committee judged it appropriate to wait,” Yellen said.

The policy statement also nodded squarely to the global economy as a decisive variable within Yellen’s “data-dependent” Fed, warning that recent developments abroad and in financial markets might restrain economic activity somewhat and likely put further downward pressure on inflation in the near term.

But the Fed maintained its bias towards a rate hike sometime this year, while lowering its long-term outlook for the economy.

Fresh economic projections showed 13 of 17 Fed policymakers foresee raising rates at least once in 2015, down from 15 at the last meeting in June.

Check video: The Indian Express Associate Editor Anil Sasi Analyses US Fed Action

Traders in futures markets cut bets that the central bank would lift rates by December to around a 47 percent probability, from 64 percent before the release of the policy statement.

“We’re in the same situation we were in before, which is uncertainty about when are they going to move,” said John Bonnell, a senior portfolio manager at USAA Investments in San Antonio, Texas.

Four Fed policymakers now say rates should not be raised until at least 2016, compared to two who felt that way in June. The Fed has policy meetings in October and December.

In deciding when to hike rates, the Fed repeated it wanted to see “some further improvement in the labor market,” and be “reasonably confident” that inflation will increase.

The dollar fell sharply against a basket of currencies after the release of the statement. Stocks initially edged higher before falling and ending the trading session lower. Prices for U.S. Treasuries rose.

‘MORE DOVISH’

Taken as a whole, the latest Fed projections of slower GDP growth, low unemployment and continuing low inflation suggest that concerns of a so-called secular stagnation may be taking root among policymakers. One policymaker even suggested a negative federal funds rate.

The median projection of the 17 policymakers showed the Fed expects the economy to grow 2.1 percent this year, slightly faster than previously thought. However, its forecasts for GDP growth in 2016 and 2017 were downgraded.

The Fed also forecast inflation would creep only slowly toward its 2 percent target even as unemployment dips lower than previously expected. It sees the unemployment rate hitting 4.8 percent next year and remaining at that level for as long as three years.

The Fed’s projected interest rate path shifted downward, with the long-run federal funds rate now seen at 3.5 percent, compared to 3.75 percent at the last policy meeting.

Fed officials like board member Jerome Powell and Atlanta Fed President Dennis Lockhart in recent months had publicly endorsed a September rate hike, forming a near majority along with longstanding inflation hawks like Richmond Fed President Jeffrey Lacker. Only Lacker, who wanted to raise rates by a quarter percentage point, dissented on Thursday.

MORE DOVISH’

Taken as a whole, the latest Fed projections of slower GDP  growth, low unemployment and continuing low inflation suggest that concerns of a so-called secular stagnation may be taking root among policymakers. One policymaker even suggested a negative federal funds rate.

The median projection of the 17 policymakers showed the Fed expects the economy to grow 2.1 percent this year, slightly faster than previously thought. However, its forecasts for GDP growth in 2016 and 2017 were downgraded.

The Fed also forecast inflation would creep only slowly toward its 2 percent target even as unemployment dips lower than previously expected. It sees the unemployment rate hitting 4.8 percent next year and remaining at that level for as long as three years.

The Fed’s projected interest rate path shifted downward, with the long-run federal funds rate now seen at 3.5 percent, compared to 3.75 percent at the last policy meeting.

“The Fed has become more dovish, with growth projections revised down amid rumblings of ‘secular stagnation.’ But there’s a clear signal that, in the absence of any serious derailing of the economy, rates will rise before the year is out,” said Chris Williamson of financial information services firm Markit.

The vote on the policy statement also was a sign of how China’s economic slowdown and market slide left Fed officials unnerved about the state of the world economy. Only Richmond Fed President Jeffrey Lacker dissented.

Fed officials like board member Jerome Powell and Atlanta Fed President Dennis Lockhart in recent months had publicly endorsed a September rate hike, forming a near majority along with longstanding inflation hawks like Lacker.

In the end, however, they were left with a muddled picture marked by low U.S. unemployment and steady economic growth, but no sign that inflation has begun to rise towards the Fed’s target.

FOMC statement from Sept 16-17 meeting

Following is the full text of the statement released by the Federal Reserve’s Federal Open Market Committee on Thursday following a two-day meeting:

Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace. Household spending and business fixed investment have been increasing moderately, and the housing sector has improved further;however, net exports have been soft. The labor market continued to improve, with solid job gains and declining unemployment. On balance, labor market indicators show that underutilization of labor resources has diminished since early this year. Inflation has continued to run below the Committee’s longer-run objective, partly reflecting declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation moved lower; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term. Nonetheless, the Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators continuing to move toward levels the Committee judges consistent with its dual mandate. The Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced but is monitoring developments abroad. Inflation is anticipated to remain near its recent low level in the near term but the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of declines in energy and import prices dissipate. The Committee continues to monitor inflation developments closely.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, 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 and international developments. The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C.Dudley, Vice Chairman; Lael Brainard; Charles L. Evans; Stanley Fischer; Dennis P. Lockhart; Jerome H. Powell; Daniel K. Tarullo; and John C. Williams. Voting against the action was Jeffrey M. Lacker, who preferred to raise the target range for the federal funds rate by 25 basis points at this meeting.

FACTBOX: US Federal Reserve interest rate policy: a brief history

World stock prices held near three-week highs and the U.S. dollar fell on Thursday as investors waited to hear whether the U.S. Federal Reserve will end its near-zero interest rate policy.

A poll by Reuters released on Wednesday showed the majority of economists now expect no rate rise later on Thursday, although it remains a close call. The futures market implied traders assigned a 1-in-4 chance of such a move.

Following is some background on the Fed’s benchmark policy rates.

* An increase in the fed funds target rate would be the first since June 2006 and would signal an end to an era of extraordinary monetary policy accommodation, during which the U.S. central bank cut interest rates to near zero and flooded the banking system with about $3.6 trillion in cash through a series of asset-purchase programs.

The Federal Open Market Committee (FOMC), the Fed’s monetary policy-setting panel, has kept the target range for the federal funds rate at 0.00 – 0.25 percent since December 2008.

An increase in the fed funds rate would likely prompt U.S. banks to change their prime rate, or the rate charged to its best customers for loans. The prime rate is currently 3.25 percent and is typically three percentage points above the top end of the targeted range for the federal funds rate.

The federal funds target rate is the target rate charged between U.S. banks for overnight loans needed to maintain their required reserve balances. The FOMC meets eight times a year to assess the health of the economy and decide what policy actions are needed to meet its two congressionally established mandates: fostering maximum employment and price stability.

The Fed considers the federal funds rate to be its primary policy tool for pursuing those two mandates. The Fed stands nearly alone among first-tier central banks in having a divided, or dual, mandate. Most of its peer banks are charged only with maintaining price stability by capping inflation, while preventing deflation.

Like most of its peers, the Fed considers a core inflation rate, excluding food and energy inflation, of about 2.0 percent as being consistent with its price stability mandate.

At present, the Fed does not have a specific target for the unemployment rate at which it considers the U.S. economy to have achieved its full or maximum employment mandate. However, after the 2008 financial crisis the Fed explicitly linked its policy with attaining an unemployment rate of 6.5 percent until 2014.

The Fed is also responsible for another important interest rate: the discount rate. This is the rate charged to U.S. banks for emergency loans directly from their local Federal Reserve bank branch. This rate is set by the boards of directors of the 12 regional Federal Reserve banks and is subject to approval by the Federal Reserve Board of Governors, not the FOMC. Because it is a penalty rate, it is always higher than the federal funds rate and is currently set at 0.75 percent.

SOME RECENT HISTORY:

* The last increase in the federal funds rate by the FOMC was on June 29, 2006, when it raised the rate to 5.25 percent from 5.00 percent, concluding a run of two years during which the FOMC had increased the rate by a quarter percentage point at each meeting beginning on June 30, 2004, when it raised the rate from 1.0 percent, then a historic low, to 1.25 percent.

* The FOMC left the federal funds rate unchanged at 5.25 percent from June 29, 2006, until Sept. 18, 2007, at which time it lowered the rate by half a percentage point to 4.75 percent during the financial crisis that year.

* In August 2007, because of signs of increasing stress in the financial system, the FOMC conducted two unscheduled meetings by conference call. At the second of those meetings, the Fed cut the discount rate to 5.75 percent from 6.25 percent.

* The easing cycle that began formally with the Sept. 18, 2007 reduction in the federal funds rate culminated with a final rate cut by the FOMC on Dec 16, 2008, when it took two important actions. It cut the federal funds rate from 1.0 percent to the current level and set a target range of 0.00 percent to 0.25 percent for the daily federal funds rate, rather than a specific target rate.

* The Federal Reserve Bank of New York publishes the daily average, known as the federal funds effective rate, each day at around 1200 GMT (0800 New York time). Since the date of the last rate cut on Dec. 16, 2008, the daily effective rate has ranged from as low as 0.04 percent to 0.25 percent. It has averaged 0.129 percent during the period from Dec. 16, 2008, until now.

* The federal funds effective rate is currently 0.14 percent and has been at that level each day so far this month.

* The easing cycle incorporated more than interest rate cuts. It included a bond-buying program known as quantitative easing designed to flood the banking system with cash to foster private credit creation and to suppress long-term interest rates to keep borrowing costs low.

* Quantitative easing had three phases: QE1, QE2 and QE3. The QE1 cycle began in November 2008 and was expanded in March 2009. QE2 began in October 2010 and was augmented in September 2011 by “Operation Twist”, in which the Fed reduced its holdings of shorter-term bonds and expanded its holdings of longer-term bonds. QE3 began in September 2012 and was expanded in December 2012. The tapering, or slowdown, of new purchases under QE3 was announced in December 2013 and was completed by October 2014.

* By the time the Fed was finished adding to its balance sheet, it had acquired $3.6 trillion of U.S. Treasuries and mortgage-backed securities over the three rounds of QE, and the balance sheet had grown to $4.47 trillion from about $850 billion. The balance sheet is roughly $4.44 trillion today.

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