Don’t look for any more direct answers like Fed Chair Janet Yellen’s “in about six months” response to a question about how soon after QE3 ends will the Fed raise short-term interest rates.
Last week, minutes from the Federal Reserve’s March policy meeting seemed to soften the previous comments regarding timing.
The Fed is holding the Federal Funds Rate at a near-rock-bottom 0.25% and has now indicated it will keep rates low even after the economy improves.
What is causing the slight but apparent shift in policy? Conflicting elements are affecting the policymakers’ deliberations:
- Turmoil in Ukraine is supplying a bid for “safe-haven” securities,
- Improved Retail Sales for March, up the most in one and half years at +1.1%,
- Uneven job growth that is lagging last year’s numbers with a CBO projection for growth to average just 164,000 this year,
- Consumer prices rose 0.2% in March and are + 1.5% YOY. So, inflation has stopped falling but still is shy of the Fed’s preferred level of 2% and the underlying inflationary backdrop remains weak.
The Fed said in the past that the two quantitative criteria for increasing rates would be reaching 6.5% unemployment and getting to a 2% inflation rate. But now, the Fed’s 6.5% unemployment rate threshold has been scrapped – reaching that level from the current 6.7% will no longer necessarily mean the Fed will increase rates. The 2.0% inflation rate is still a goal, but the Fed now will depend on a more “qualitative,” though unspecified, approach to determine policy.
In response to the Fed’s apparent shift, Treasury rates fell with the reassurance of continued cheap money. Market activity reversed much of earlier “curve flattening” – the Wall Street term for a rise in short-term rates due to an expectation of a Fed boost in rates -- that had occurred after Yellen’s earlier comments. Ten-year yields decreased to 2.62%, a level not seen since March 3.
Chairwoman Yellen spoke Tuesday morning at an Atlanta Fed conference and focused her comments not on rates but on lending, another data point. The Federal Reserve is considering new rules to address risks in short-term funding. One likely rule would require larger and complex banks to hold greater amounts of capital, or highly liquid assets, to support stable funding.
What this has meant for the 504 program is an Effective Rate for borrowers of 5.19% in April, which is the lowest since June 2013 when rates spiked due to reduced Fed purchases in the QE3 program. Along with this reduced cost of funds has been recent, increased monthly loan volume that exceeds the twelve-month average of $336,000,000.
The Fed’s policy leadership is taking a more qualitative approach in determining its direction, abandoning previously adopted quantitative trigger points. While that may cause confusion or even consternation for rate watchers, the market is perfectly capable of moving on its own – ahead of official policy guidance.