The Federal Reserve Bank’s most recent monetary policy meeting concluded this past Wednesday and, as mostly usual, offered polarizing fodder for the future monetary policy. The official changes to policy included the following:

• A reduction in the monthly pace of the quantitative easing program (buying long-term U.S. Treasury bonds and mortgage-backed securities to control the level of interest rates) by another $10 bln to a level of $55 bln per month starting in April.

• Changes to the Fed’s “forward guidance” program:
     - Doing away with the 6.5% unemployment rate “threshold” that previously characterized changes to the future path of short-term interest rates (this was largely expected).
     - "The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2% longer-run goal, and provided that longer-term inflation expectations remain well anchored."
     - "The Committee’s 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 developments."

The change to forward guidance can be interpreted two ways. By removing the 6.5% unemployment threshold and adopting something that incorporates wider employment adoption, the Fed effectively increases the burden of proof for a healthy economy and, ultimately, higher interest rates. However, by not specifically stating what the new employment threshold will be, the public is left to its own devices in trying to figure out the path of future monetary policy.

The Fed routinely updates the public with its expectations for future GDP growth, unemployment rate, and inflation along with a median forecast for the future level of short interest rates that it controls. This caused the most angst among investors as the Fed’s expected level of interest rates at the end of 2015 and 2016 is now higher than the December forecast: 2015 at 1.0% up from 0.75% and 2016 at 2.25% up from 1.75%. It does seem that the Fed is getting more confident in their forecasts and as such paving the way for earlier interest rates rises.

The important thing to remember is that future monetary policy moves will depend critically on the economic data and the inflation outlook i.e., interest rates will likely rise ONLY if durable economic growth manifests.


Source: The Federal Reserve Bank