THE US Federal Reserve has set the stage for three more years of ultra-loose monetary policy in the world’s largest economy, prompting an immediate plunge in bond yields.
The Fed predicted low interest rates until at least late 2014 and set a formal inflation objective of 2 per cent as Ben Bernanke’s long campaign to make the central bank more transparent was put into action. The Fed’s previous forecast was for rates to be kept on hold until mid-2013.
The yield on $35 billion worth of five-year notes sold just before the statement was published dropped 10 basis points to 0.80 per cent, while the yield on 10-year notes fell 11 basis points to 1.95 per cent.
The change in the expected period of low rates until late 2014 came as the Fed released a swathe of new information on its policy plans, including forecasts of future interest rates. These revealed deep divisions within the Fed: three out of 17 officials would like to raise rates this year, while two think that the first rise should not come until 2016.
The divergence of views is an early challenge to the new communications framework that Mr Bernanke has championed for more than a decade.
The biggest part of that framework is the 2 per cent inflation number that binds the whole of the rate-setting Federal Open Market Committee (FOMC) to a single objective for the first time.
“The FOMC statement is slightly more dovish than expected and this has seen a knee-jerk drop in the dollar and a US equities bounce,” said Marc Chandler, currency strategist at Brown Brothers Harriman.
The SP 500 was up 0.2 per cent shortly after the statement, having recovered from a loss of 0.2 per cent before it was published. The dollar was trading 0.1 per cent higher after dipping as much 0.8 per cent on a trade-weighted basis. Gold rose more than 2 per cent to a six-week high of $1,694 a troy ounce.
Keeping a forecast date for the first rise in interest rates in its policy statement, and extending that date by more than a year, suggests the Fed wants to minimise any confusion from the new communications policy. It shows that, regardless of the individual interest rate forecasts of FOMC members, the committee as a whole is committed to keeping rates low until the economy recovers.
But it also suggests that the FOMC wants to do all it can via communications policy before considering another round of quantitative easing, nicknamed QE3.
The FOMC voted for the decision by 9-1. The only dissenter was Jeffrey Lacker, president of the Richmond Fed, who wanted to leave the late 2014 date out of the policy statement. – (Copyright The Financial Times Limited 2012)
