Is the Fed Poised for Some Policy Changes?

If senior officials listen to their own economists, the answer will be yes.

At present, the Fed expects to begin raising interest rates when the unemployment rate drops to 6.5% and inflation rises to 2.5%.

Now a half-dozen Fed economists are recommending that the unemployment objective should be lowered to 6% or even 5.5% before any change. They believe the economy will simply perform better if they hold off.

This is in part due to the fact that unemployment numbers don’t mean the same thing they meant a decade ago. We’re now experiencing a 35-year low in labor market participation. This is in large part due to the number of workers who have given up on finding a job and simply dropped out. Those “drop-outs” are not counted in the overall unemployment figures.

Some believed that a decrease in emergency unemployment benefits would get people back to work. However, the decrease took place without doing much to increase employment. It turns out most people weren’t receiving unemployment benefits because they didn’t want to work – it was because they could find no work.

Now the implementation of Obamacare has put thousands more in the “under employed” category, as large employers cut hours to avoid providing insurance. A store clerk gave me an earful about that situation just this week.

Now economists are recommending that the zero-bound interest rates remain in place until at least 2017 and kept below normal into the early 2020’s.

At present, companies are using the low interest rates to raise record levels of debt capital – which could in turn lead to expansion, more jobs, and a stronger economy.

Keeping rates at our near present levels will also continue to benefit the housing market, as lower mortgage interest rates mean more individuals and families can afford a house payment.

The Fed may also be considering an earlier than anticipated reduction of Quantitative Easing – perhaps as soon as March. Right now the central bank is pumping $85 billion per month into bond-buying. Its balance sheet recently stood at more than $3.8 trillion.

While the stock market went into shock in May when a reduction was discussed, economists now believe that the stock market won’t suffer as long as low interest rates remain in place.

Will the economy respond as expected? Are these the right moves?

Only time will tell.

Mike Clover
Mortgage Banker
www.mikeclover.com